ECB heads for crunch time af­ter weeks of hold­ing its nerve

Business Standard - - WORLD - FERGAL O'BRIEN BLOOMBERG

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. Here’s what Pres­i­dent Mario Draghi and some of his col­leagues on the Gov­ern­ing Coun­cil have said re­cently about the econ­omy and in­fla­tion, and what it might mean for mone­tary pol­icy in 2019.

Mario Draghi, Brus­sels, Novem­ber 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, Novem­ber 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, Novem­ber 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 per­cent 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, Novem­ber 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 per­cent in 2019 and 1.7 per­cent in 2020 are above con­sen­sus, which the lat­est Bloomberg sur­vey puts at 1.6 per­cent and 1.5 per­cent.

In­fla­tion — cur­rently seen at 1.7 per­cent 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: Pol­icy mak­ers 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 U.S. 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.

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