It has been quite a 24 hours in the Euro area and in the Frankfurt Towers of the ECB. Let me start with something that in a way is epoch making at least in the arena of monetary policy.
Today, in line with the Governing Council’s strong commitment to its price stability mandate, the Governing Council took further key steps to make sure inflation returns to its 2% target over the medium term. The Governing Council decided to raise the three key ECB interest rates by 50 basis points and approved the Transmission Protection Instrument (TPI).
So the era of negative interest-rates which began in 2014 is now over, at least for now. The ECB Deposit rate is now a literal example of ZIRP or Zero Interest-Rate Policy rather than NIRP. It makes me wonder if the ECB still thinks this?
Central banks which have adopted NIRP are generally positive about its use in helping them
fulfil their objectives……..The ECB’s own
research is confident that the effect of NIRP on these variables ( output, employment and inflation( in the short- to medium-term is positive at this stage.
President Lagarde was rather quiet on this issue yesterday. Anyway let us advance noting that after one of the clearest examples of Forward Guidance as shown below it was obviously abandoned.
Accordingly, and in line with our policy sequencing, we intend to raise the key ECB interest rates by 25 basis points at our July monetary policy meeting. ( ECB June 9th)
Regular readers will be aware that I have never been a fan of Forward Guidance and this week’s development where suddenly “sauces” were suggesting a 0.5% increase was rather a mess. Unfortunately President Lagarde looked rather confused as to what her position now is because whilst declaring “all bets are off on her previous hints for September she also said this.
So what happens in September is going to depend on what data we have for September, but we are definitely on a normalisation path, in order to reach our medium-term objective of 2%.
So her medium-term objective is for an interest-rate of 2%? Then there was this bit which seems to say that whilst it is different it is also the same.
We are accelerating the exit, and we are following the path of normalisation that we have flagged.
So the waters which could easily have been clear were suddenly rather muddy or as Oasis would put it the end of Forward Guidance was “Definitely Maybe”
Desperation
We also got something which was extraordinary and shows the mess that the ECB finds itself in.
Now, the TPI is, obviously, an instrument that will help us deliver on our mandate of price stability, bringing inflation in the medium term back to 2%, and under that TPI all members of the euro area can be eligible; all of them.
Yes we are back to Italy and yes the committee meetings came up with a name change as the Transmission Protection Mechanism or TPM became the TPI with the I being Instrument. That is never a good sign because it suggests that they should have been concentrating on its design which turned out to be an issue.
But the point is that for so long central banks have told us QE bond buying raises inflation ( that was its original rationale) and now apparently it also reduces it! Unless of course the plan is to push it even higher. Next up is the rather bizarre claim that Germany is included and we can widen that to the 5/6 core nations because by definition they cannot be fragmenting.
Next we will have clear criteria except we were going to have to wait a bit for them.
Subject to being considered by the Governing Council as eligible to the TPI, on the basis, notably – notably, not exclusively, it will be the discretion of the Governing Council to make the decision – notably on the basis of criteria that are very specifically spelt out.
Then in a change of mind she told us.
In particular, the criteria include: (1) compliance with the EU fiscal framework:
(2) absence of severe macroeconomic imbalances
(3) fiscal sustainability:
(4) sound and sustainable macroeconomic policies:
But then we got another swerve because we then got this.
So you have a combination of criteria ranging from fiscal to macroeconomic, to compliance with the RRPs [Recovery and Resilience Plans] in particular, and obviously the DSA [Debt Sustainability Analysis]. So all these four categories will be taken into account by the Governing Council.
Only “taken in account” and then suddenly maybe ignored.
But once again, the Governing Council decides in sovereignty in respect to eligibility to the TPI.
So democratically elected governments will be subject to the technocratic ECB? This takes us back to October 2010 when ECB President Jean-Claude Trichet wrote a letter to the Irish government effectively setting its fiscal policy for it. This was also “strictly confidential” and was only released in 2014 after a lot of protests.
The Euro
The exchange-rate gives us some sort of perspective and there had been a move this week in response to the “sauces” with the Euro moving away from parity with the US Dollar to above 1.02. As I type this it is at 1.015 showing that the confusion described above has offset the change in relative interest-rates. Against the UK Pound the Euro rallied to 0.8576 but now has fallen back to 0.85.
The Economy
In a rather extraordinary example of timing this was released this morning by Markit.
“The eurozone economy looks set to contract in the third
quarter as business activity slipped into decline in July
and forward-looking indicators hint at worse to come in
the months ahead.”
Actually if we look into the detail it got worse.
“Excluding pandemic lockdown months, July’s contraction
is the first signalled by the PMI since June 2013, indicative
of the economy contracting at a 0.1% quarterly rate.
Although only modest at present, a steep loss of new
orders, falling backlogs of work and gloomier business
expectations all point to the rate of decline gathering
further momentum as the summer progresses”
So whilst the decline is minor at the moment it is expected to accelerate. Also in a particular warning to Germany it is being led by this.
“Of greatest concern is the plight of manufacturing, where
producers are reporting that weaker than expected sales
have led to an unprecedented rise in unsold stock.
Production will likely need to be reduced as companies
adapt to this weaker demand environment, in turn widely linked to rising prices”
They then rather pile on the gloom.
“Business expectations for the year ahead have
meanwhile fallen to a level rarely seen over the past
decade as concerns grow about the economic outlook,
fuelled in part by rising worries over energy supply and
inflation but also reflecting tighter financial conditions”
Comment
So the story starts with an exit from negative interest-rates and something immediately worried me. From my twitter feed.
Should the ECB follow the 2011 timetable then its interest-rate will be back at -0.5% in late spring 2023.
President Lagarde assured us this and the emphasis is mine.
We look at our projection dating back to June, we look at the most recent forecast published by the Commission last week. Under the baseline scenario there is no recession, neither this year nor next year.
Of course she also assured us that there would be no inflation either. But as we have already noted the Markit PMI has pointed in that direction they very next morning. Just for clarity although it has caught up with my view I have no great faith in it as a measure but she and her colleagues do.
Regular readers will recall I have kept making the argument that timing really matters in monetary policy and that is why it was important to act last year. Or as Bananarama put it.
It ain’t what you do, it’s the way that you do it
It ain’t what you do, it’s the way that you do it
It ain’t what you do, it’s the way that you do it
And that’s what gets results
It seems that others have caught up with this point of view.
Bond market to ECB: good job hiking 'one and done'. pic.twitter.com/qFYYRZMiIs
— Frederik Ducrozet (@fwred) July 22, 2022