Is the ECB driving “like crazy at night with our headlights turned off”?

by Shaun Richards

After a week so far which has seen UK and US economic figures take centre stage there is the issue of the state of play in the Euro area. As its central bank the ECB is so keen on expectations ( reality is much less easy to manipulate), let me  start with those.

LONDON, Feb 16 (Reuters) – The European Central Bank will raise its deposit rate at least twice more, taking the terminal rate to 3.25% in the second quarter, with a vast majority of economists polled by Reuters saying the greater risk is it goes even higher.

ECB President Christine Lagarde said at a news conference this month that the euro zone’s central bank would add 50 basis points to the deposit rate. Economists took her at her word, with all 57 of them polled in the Feb. 10-15 period expecting a deposit rate hike to 3.00% at the March 16 meeting.

There are various consequences from this but before we get to them the consensus that some of you may recall was a major aim of President Lagarde does not seem to be going so well.

In this setting, I will argue that the ECB should not unconditionally pre-commit to future policy moves. Instead, we need to calibrate our monetary policy in a way that is data-dependent, forward-looking and adaptable to changing developments.

That is from Fabio Panetta and he is effectively echoing the words of former President Mario Draghi. He is also speaking in London which I thought was supposed to be replaced by one or all of  Frankfurt, Paris, Brussels or Madrid? Anyway that is very different to the words of President Lagarde at the European Union parliament yesterday.

In view of the underlying inflation pressures we intend to raise interest rates by another 50 basis points at our next meeting in March, and we will then evaluate the subsequent path of our monetary policy.

Although, as ever , she contradicted herself virtually immediately.

Our future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.

These days the woman who dismissed inflation as a “hump” that would soon be over is presenting herself as a valiant inflation fighter.

This is why the Governing Council started a process of policy normalisation in December 2021 and raised the ECB interest rates by 300 basis points since July 2022.

I guess she hopes they wont spot she only started 7 months ago.

Bond Yields

There are consequences to the combination of action and rhetoric as the German ten-year yield has been approaching 2.5%. You may note that it is already looking forwards to future interest-rate cuts but my point is that we have moved from a world where Germany was paid  to borrow via negative bond yields to one where it costs. This comes at a time when due to the energy crisis Germany is borrowing.

On balance, the deficit will rise from
2¾% of GDP this year to 4% next year ( Bundesbank)

Also there is this.

The interest burden would rise to some 40 billion euros from 29.6 billion estimated by the government. This would be 10 times the expenditure of 3.9 billion euros in 2021.  ( Reuters)

If we switch from the benchmark to more troubled debt situations there is of course Italy. Even it had some negative bond yields which was the clearest sign of ECB QE buying distorting markets but now it has a ten-year yield of 4.3%. The fiscal situation is really rather different to the German one and may well be much more affected by this.

As communicated in December, the APP portfolio will decline at a measured and predictable pace, with the decline amounting to €15 billion per month on average from the beginning of March to the end of June 2023 and its subsequent pace to be determined over time. ( President Lagarde)

This is because the ECB was not only the swing buyer for BTPs ( Italian bonds) there were times it was pretty much the only one. Who else would buy them at negative yields? Well now we face the prospect of the ECB actually selling some.

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MILAN, Dec 21 (Reuters) – Italy’s average borrowing costs in 2022 reached their highest level in almost a decade at 1.71% due to higher bond yields and sky-high inflation, the Treasury said on Wednesday.

The ministry forecast Italy’s medium- to long-term gross funding needs for 2023 at 310-320 billion euros ($669 billion).

There are several factors in play here. At first the extra costs will be hidden in that revenues in the Euro area come from nominal GDP which is affected by inflation ( and why governments like inflation). So things gets tougher for it when the inflation fades. But the worker and consumer gets hurt bu both factors as fiscal drag is at their expense.

If we now switch to the ECB then the monthly sale of bonds will be at large losses and in the case of BTPs very large ones. Capital losses will depend on markets at the time but we can estimate the flow losses.

Our European team projects the depo rate at 2.5% by next March, which implies ECB losses of around €40 billion next year. Bank deposits receive the depo rate, which will be much higher than the yield on the portfolio. ( Financial Times)

So more like 45 billion Euros now and maybe 50 billion. This is an awkward one.Will the ECB go bankrupt? No. But in a world when governments benefited from the ECB buying their bonds  extremely expensively then one needs to account for losses as  well.

Mortgage Rates

The ECB calculates the cost of a typical mortgage and you will not be surprised to read they have been rising as both official interest-rates and bond yields have been rising.So as Martha and the Vandellas put it.

Nowhere to run to, baby (nowhere to run, nowhere to hide)Nowhere to hide (ooh-ooh-ooh)Got nowhere to run to, baby (nowhere to run, nowhere to hide)Nowhere to hide (ooh-ooh-ooh)

The measure was 1.31% in December 2021 and 2.94% last December. The cheapest is France at 2.04% and the most expensive Lithuania at 4.35%. Rather curiously Italy at 3.34% is not only cheaper than Germany at 3.5% but 1% or so lower than what its own government can borrow at!


There is quite a bit going on here and let me start with higher bond yields. It is not the best time for them.

European Union countries have now earmarked or allocated 681 billion euros in energy crisis spending,  ( Reuters)

Maybe one day someone will wonder why we always seem to be in a crisis? There are specific issues from this and one of them is that Fabio Panetta is Italian.

There is little reliable experience of balance sheet tightening. It is hard to assess how a contraction of our balance sheet will affect bond markets and financial stability – especially if it happens in conjunction with an abrupt increase in interest rates.

So central banks having “saved” everyone are now making things worse for them and ironically themselves as it is their own interest-rate rises which punish them. QE is revealed as much more of a Jedi Mind Trick than they tried to claim. Then there is the issue of negative wealth effects as higher mortgage rates affect house prices in what for central bankers is what Britney sang about.

Don’t you know that you’re toxic?And I love what you doDon’t you know that you’re toxic?

Switching back to Fabio Panetta it seems he is troubled by ECB policy too.

What we do not want is “to drive like crazy at night with our headlights turned off” – as Italian singer Lucio Battisti once put it.


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