ECB: “United we Stand”

Published on November 6, 2014

Despite continued signs of weakness in the Eurozone economic data, there was little to no expectation for any further action from the European Central Bank Governing Council at today’s monthly Monetary Policy Committee, especially in light of the series of easing measures implemented since last June.

President Mario Draghi did nevertheless reiterate the ECB was “unanimously” committed to taking further steps, if need be, which by definition at the zero lower bound would be “unconventional.” He reinforced that commitment further in pointing out that ECB staff has been tasked to actively evaluate additional easing options it might take, again, if need be.

*** A readiness even after the measures already taken by the ECB to ease further if need be was and is clearly an important message for markets to hear. But the most important message the ECB delivered today was not in indicating it was necessarily moving closer to additional easing – we believe it is in a “wait and see” mode for now. It was rather one of unity, namely that if it saw the need to ease further the Governing Council would not hesitate to act – an important message in and of itself – and furthermore, it stood united in targeting an expansion of its balance sheet in order to meet its objectives. ***

*** That message of unity of purpose was in direct response to a series of articles highlighting nasty and even perceived bitter personal divisions between hawks and doves on the Governing Council, led by the German Bundesbank’s Jens Weidmann on one side, and Draghi himself on the other. Those divisions have increasingly become the focus of markets and the press as a potential limitation on the ECB’s room for further action, and damaging as such. The powerful pushback and message of unity today was deliberate, and we believe with the full and more than willing consent of the entire council, including the hawks. ***

*** What was equally important was the second key part of the today’s message, laying out the conditions under which the “united ECB” would agree to take further action. Those were if the ECB were to deem the current measures taken insufficient, or if the ECB were to revise its forecasts materially downwards again. Note that going into next month’s critical quarterly forecast meeting, as things stand, the ECB already expects extremely low inflation prints, with inflation rising gradually in 2015 and 2016. ***

*** We suspect the GC preference will therefore continue to be to remain on hold in December and wait until Q1 2015 to assess the impact of the measures already taken. While the ECB has signaled a willingness and unity of purpose to ease more if needed, which we take seriously and believe to be a critical and extremely positive message to markets, we do not interpret today’s meeting and post meeting communications necessarily as a signal or desire to encourage actual expectations of an ease at the upcoming December meeting – barring further downside shocks. ***

On Expanding the Balance Sheet

Draghi and the ECB Governing Council members went to great lengths today to find the most effective means to communicate and highlight the areas of Council consensus, leave the door open to actions they are willing to take, but at the same time not pre-commit to decisions they are either unwilling or not yet ready to take.

Most important of these signals was the reiteration and the deliberate inclusion of the goal to expand the ECB balance sheet to early 2012 levels in Draghi’s official opening statement – where it is agreed to and formally signed off on by every Governing Council member.

Draghi furthermore went on, in the question and answer segment, to explicitly clarify what the ECB meant by “early 2012” balance sheet levels; that would be March of 2012. His response came with no hesitation, which indicates to us the answer was also clearly discussed and agreed to by the GC.

For reference, the balance sheet at that time was 3 trillion Euros (3.023 to be more precise at the end of February, before the March 8, 2012 ECB meeting), and the latest figure as of October 31 was 2 trillion (2.052). That confirms an ECB expansion target of around 1 trillion Euros, the higher end of market estimates.

The inclusion of this balance sheet expansion target in the statement and further clarification of its magnitude is intended to reinforce the commitment of even the hawks, first and foremost the Bundesbank, to the policy.

That was necessary because, in reality, from what we understand there was initially some internal resistance to shifting the ECB towards an explicit goal of expansion of its balance sheet. That resistance was on two fronts.

One was regarding the credit risk the ECB would be assuming – the main reason behind various members, including rather surprisingly the Banque de France’s Christiane Noyer, dissenting on ABS purchases when they were first announced.

The other was on the mandate and moral hazard front, in that setting an ambitious goal of balance sheet expansion could very well open the door to potential sovereign bond purchases if and when needed, especially given the difficulties that may arise in meeting that balance sheet expansion goal through the agreed to TLTRO loans and ABS and Covered Bond purchases alone.

And so today the ECB took a major step in reaffirming its commitment to balance sheet expansion, but in the process also clarifying what exactly that consensus means, and does not mean.

Defining the Areas of Agreement

The most important new clarification on the balance sheet expansion target today to us was not the (very welcomed) affirmation of the trillion Euro goal mentioned above, but in defining the GC’s consensus expectations on timing – that the balance sheet was expected to hit that additional 1 trillion Euro target to get to the 3 trillion Euro level over about two years.

That target should be seen in light of the current  universe of ABS and Cover Bonds eligible for ECB purchases of 1 trillion Euros, with the expectation (and hope) that issuance in those will expand dramatically over time as the ECB continues its program.

That means the ECB can (theoretically) hit those targets without any new programs if there is no need for additional ease. Maybe, maybe not.

What it does do is in effect remove any direct pressure or market expectations for imminent new asset purchase programs from the ECB for pure balance sheet purposes – it will make that decision only if there is a pressing reason on the forecast or financial conditions front.

That is a flexibility that will be appreciated not just by hawks, but we suspect by the Governing Council at large.

Draghi also went at great lengths today to address issues of the “composition” in addition to the size of the balance sheet – addressing allegations over the ECB becoming a “bad bank” for the Eurozone with hard statistics on the credit quality and safety of its current purchase programs. Addressing the balance sheet safety issue will become even more important if the ECB were to choose to embark on corporate bond purchases.

And Draghi made the case convincingly and in style, adding that he had little hope in converting the most fervent critics of ECB policy even with overwhelmingly convincing data – as “when evidence meets faith, evidence inevitably loses.”

But he did indeed convince his fellow travelers on the ECB, including hawks, at least as far as current programs are concerned, and we suspect that message may find its way more broadly in political circles as well.

As to sovereign bond purchases, they are within the ECB mandate, they have been and continue to be an option on the table, but are nevertheless still controversial. In this, there is nothing new.

As we have said repeatedly, we have little doubt the ECB will cross the sovereign bond purchase Rubicon if and when it has to. But that does not mean the process will be an easy one – with a wary eye still on the European Court of Justice case pending on the OMT purchase program.

But in the meantime the message is clear on the Euro – we are expanding our balance sheet while others are contracting theirs.

There is ample reason for the Euro to continue to fall due to fundamental economic and monetary policy cycle differentials between the Eurozone and others (the US). And with no currency intervention in sight, there is little reason for any monetary policy official to be overly bothered by these fundamentally driven moves. So, see you in December.

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