What can the ECB and Christine Lagarde do next?

by Shaun Richards

Today is a policy meeting day for the European Central Bank and it has a lot to think about. One way of reflecting on this is just to simply note where it presently stands in terms of policy.

First, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00 per cent, 0.25 per cent and -0.50 per cent respectively.

The operative rate for the banks was in fact not mentioned last time around,perhaps it is considered too embarrassing at -1%. But it looks increasingly permanent.

Third, the Governing Council decided to further recalibrate the conditions of the third series of targeted longer-term refinancing operations (TLTRO III). Specifically, it decided to extend the period over which considerably more favourable terms will apply by twelve months, to June 2022. Three additional operations will also be conducted between June and December 2021.

So rather than further interest-rate cuts the mood music has shifted towards keeping them where they are for longer. It is a relief that they do not seem to be looking at the “Micro-Cuts” hinted at yesterday by the Bank of Canada. After all the interest-rate cuts we have seen does anyone sensible actually believe another 0.1% would make any difference?

Next comes the issue of bond buying or the manipulation of longer-term interest-rates or bond yields. Here we have a rather extraordinary situation where the ECB is running two programmes at the same time! The main one was extended in both size and time at the last meeting.

Second, the Governing Council decided to increase the envelope of the pandemic emergency purchase programme (PEPP) by €500 billion to a total of €1,850 billion. It also extended the horizon for net purchases under the PEPP to at least the end of March 2022.

There was a time when 500 billion Euros seemed a lot but no longer in this context. Also the previous programme appears as something of an after thought these days which is revealing.

Sixth, net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion

The other part that is revealing is the way it now fits with our “Too Infinity! And Beyond!” theme.

The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

The Euro

There has been a little relief here for the ECB as the Euro has weakened a little recently. It is a bit over 1.21 versus the US Dollar and the UK Pound £ has rallied above 1.13 this morning. However the ECB started its open mouth operations versus the Euro some months ago at 1.18 versus the US Dollar so it has lost ground.

The real issue here is a more conceptual one as the ability of a central bank to influence its currency has changed in the credit crunch era. It is hard for an interest-rate cut to have much of an impact when interest-rates are so low in so many places. The issue of QE is the same except it is hard for more of it to have an impact. There was a time when the extra 500 billion Euros announced last time would depress the currency but in fact it was expected and over that period the Euro rose. That leaves intervention against a strong currency but as the Swiss have discovered although in theory it should work, in practice even promising unlimited intervention has achieved nothing much. At best it has stopped the Swiss Franc going even higher, but that is almost impossible to quantify.

The other tactic is open mouth operations and there the ECB does have a strength in Christine Lagarde as she can be relied upon to say something stupid. Who can forget the claim that the ECB was not their to “close bond spreads” last year which torpedoed the Italian bond market? Also there was her claim that the Greek bailout was “shock and awe” although to be fair that was partly true as the economy collapsed and went into a depression from which it has never recovered. Maybe they could add something to the script she reads from at the press conference.

The Economy

The problem here is that we were supposed to be in the recovery now whereas economies will contract again this quarter. The central banking response is simply to push the recovery back in time.

Nevertheless, real GDP will recover only gradually, reaching the 2019 pre-crisis level by mid-2022 and exceeding it by 2½% in 2023.

Essentially they took 1% off growth this year as reality forced them too but rather than learn from that they simply added it to 2022! But there is a catch because we will be weaker for longer with the implication for debt and people’s incomes as well as business survival.

I would say the forecasts are a random number generator but I think that is unfair on random number generators. Once the restrictions ease we know the economy will bounce back and in the third quarter of last year it did so more strongly than people thought. But we do not yet know when they will be over and we do not know how the economy will then grow? We came into the pandemic with a Euro area that already was struggling for economic growth. This has been a credit crunch era issue.

Comment

We can take that forwards and give ourselves some perspective by simply asking when the ECB will raise interest-rates. On growth grounds that looks awkward to say the least as the economy is still shrinking and the ground that will hopefully eventually be regained merely takes the ECB back to a place where it felt things were bad enough to ease policy. Inflation could rise towards and indeed above target as we note the way the oil price has risen with Brent Crude Oil around US $56 per barrel and other factors such as shipping costs rising.

But there is a rub as Shakespeare would put it. That is that all the extra debt taken on by the weaker countries has been oiled by the low bond yields we see. Indeed as a result of the ECB’s policy many are negative even in places you might not expect. As countries borrow ever more due to the longer lasting nature of the pandemic the amount of debt taken on will make it ever harder to raise interest-rates and bond yields. We got some news on this front from Eurostat earlier.

Compared with the third quarter of 2019, the government debt to GDP ratio rose in both the euro area
(from 85.8% to 97.3%) and the EU (from 79.2% to 89.8%): the increases are due to two factors – government debt
increasing considerably, and GDP decreasing.

If we look ahead to the bounceback then we can (hopefully) omit the “GDP decreasing” impact but the Euro area had in the year to then added approximately I trillion Euros of extra debt. That will be continuing last quarter and this. As an aside Greece was just on the edge of 200% relative to GDP (199.9%).

Another way of looking at this is that once you deploy monetary policy on this scale you become a subsidiary of fiscal policy and QE becomes something sung about by Queen.

I’m a shooting star leaping through the sky
Like a tiger defying the laws of gravity
I’m a racing car passing by like Lady Godiva
I’m gonna go, go, go
There’s no stopping me

It is also going to get ever harder to explain another consequence of all this to first-time buyers.

In the third quarter of 2020, house prices, as measured by the House Price Index, rose by 4.9% in the euro area
and by 5.2% in the EU compared with the same quarter of the previous year

 

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