European Central Bank officials have gone silent on monetary policy after weeks of holding their nerve in the face of waning confidence, slowing growth and mounting economic risks.
The Governing Council is just days out from its December 13 meeting, when it will probably call time on one of its major crisis tools. The buildup to the end of net asset purchases after spending 2.6 trillion euros ($3 trillion) has been anything but smooth, with multiple indicators falling and two of the euro area’s biggest economies – Germany and Italy – contracting.
Mario Draghi, Brussels, Nov. 26:
“...risks relating to protectionism, vulnerabilities in emerging markets and financial market volatility remain prominent.”
“The underlying strength of domestic demand and wages continues to support our confidence that the sustained convergence of inflation to our aim will proceed, and will be maintained even after a gradual winding down of our net purchases.”
Officials have largely downplayed the euro area’s summer slowdown, blaming it on temporary issues (such as German car production) and predicting a rebound this quarter. While acknowledging the threats, they’ve stuck to their line even as some numbers suggest the bounceback may not be much to cheer about.
Peter Praet, Frankfurt, Nov. 26:
“Surveys of euro area business activity and sentiment indicators have softened perceptibly relative to their earlier highs, although they remain in expansionary territory and are still above long-term averages for most sectors and countries.”
Praet is the ECB's chief economist and writes the policy proposals. He's been at pains to say that capping quantitative easing is a far cry from actually tightening.
“Significant monetary policy stimulus is still needed… The end of net asset purchases is not tantamount to a withdrawal of monetary policy accommodation.”
Simply put, the view is that this is a slowdown, not the onset of a deeper slump. And it’s true that the Purchasing Managers Indexes for the euro zone remain above the key 50 line, and sentiment indicators were, in many cases, at multi-year highs. Some pullback was to be expected.
Jens Weidmann, Berlin, Nov. 14:
“Fluctuations in the data can’t hide the fact that the economic upturn in Germany and the euro area remains intact.”
Weidmann’s comments came as data showed Germany shrank 0.2 per cent in the third quarter. No policy maker has suggested extending asset purchases into 2019. But of course, data dependence is the mantra of the central banker and the ECB will have to respond to as needed. According to the French member of the Governing Council, the ECB needs to remain “harmonious” as the score changes.
Francois Villeroy de Galhau, Tokyo, Nov. 19:
“Like any orchestra, we need to be able to adapt the normalization of our monetary policy tempo (allegro or andante) and intensity, according to economic data. In short, we are very clear about our objective – normalization following non-standard policies – and about our sequence, but we should remain very pragmatic along our path.”
What Does It Mean
New Forecasts: There will be a lot of interest in new ECB economic projections that will include 2021 for the first time. Growth might be downgraded given the faltering outlook. The September projections of 1.8 per cent in 2019 and 1.7 per cent in 2020 are above consensus, which the latest Bloomberg survey puts at 1.6 per cent and 1.5 per cent.
Inflation – currently seen at 1.7 per cent for each of the next two years, compared with a goal of just under 2 percent – is more complicated. Energy prices have slumped but wage pressures in some countries are mounting. Estimates of the underlying rate will be key.
Balance of Risks: Policymakers have noted increased external hazards such as trade protectionism, but have been careful to stress that the overall risks to growth are still broadly balanced. Any weakening of that language this month would be a big deal, and make it harder to halt QE. They may have caught a break now that the US and China have agreed a trade-war truce (even if temporary).
Bond Reinvestments: Even after net asset purchases stop, the ECB will reinvest the proceeds of maturing debt, and sees that as a crucial to maintaining a loose policy. It hasn't yet decided a full strategy on how and how long to do that though, and investors are seeking answers.
Interest Rates: The ECB has said it will keep rates unchanged “at least through the summer of 2019” – economists see no move until at least the fourth quarter. Draghi will be asked if the weaker economic outlook could push the timing further out. There's also the question of how far off the ground rates can go, especially with the U.S. expansion aging and the Federal Reserve signaling caution on its own future hikes. Still, expect Draghi to dodge both questions on Thursday.
Any Other Business: There’s been talk of a new round of cheap loans for banks, with Italy often mentioned as a reason. Praet has said it would be premature to decide now, but almost three-quarters of respondents to a Bloomberg survey said they expect an announcement of such funding early next year.