The ECB – for real?
- In terms of all-time great press conference disruptions, that Iraqi bloke throwing his shoe at George W Bush back in 2003 is hard to beat. A 4.5-star rating goes to the glitter bombing of Mario Draghi at an ECB presser back in 2012 (photo below courtesy of CITY A.M.). Given the dour times in which we live, it was probably to be expected that ECB President Lagarde admonished Greenpeace activists for landing a paraglider on the roof of the ECB’s Frankfurt headquarters ahead of the meeting on the 12th March as part of an ESG-related protest. Madame Lagarde insinuated that landing on the roof was a Covid-19 health risk. Really?
- The low-octane ‘revelation’ from the previous ECB meeting was that the pandemic emergency protection programme (PEPP) ‘envelope’ of €1.85tn may not be fully utilised if it is not needed. Yet at almost every opportunity since then, ECB board members have been talking up intervention and bond buying in almost complete contradiction to the official policy stance at the meeting. The proximate cause has been a rise in global bond yields. Long gone are the days when rising yields were a mark of reflation, recovery and normalisation – now they are a threat to solvency due to the massive stock of debt outstanding. If one were to need an accurate assessment of the extraordinarily odd place the global economy currently finds itself, then this is it.
- ECB board member and dove-in-chief Fabio Panetta took up an apparently new and more radical policy stance in a speech delivered at Bocconi University on the 2nd March while talking on the subject of recovery from the pandemic. Mr Panetta explained how inflation expectations, despite a likely short-term spike, would remain low, that investment would remain subdued, and that the recovery would be slow and uncertain. It was therefore beholden on the Central Bank to act more aggressively.
- In the main thrust of the speech, Mr Panetta seemed to be making the case for yield-curve control. Quote:
- Mr Panetta went on to say, “My main message today can be summed up with the title of a song by the electronic music duo Daft Punk: “Harder, better, faster, stronger.” RIP Daft Punk, but quite what a couple of French DJ’s famous for their big, shiny helmets has to do with monetary policy is anyone’s guess. Are these guys for real?
- Yield-curve control (YCC) commits central banks to maintaining the nominal yield on bonds at various parts of the curve at pre-determined levels through open-market purchase operations. Some central banks are doing this already – the Reserve Bank of Australia (RBA) has a 0.10% target on the 3yr bond, while the Bank of Japan (BoJ) has a 0% target on the 10yr with a plus or minus 20bps range. The Fed has floated the idea as well, although it seems to be a long way from being policy right now.
- This would be a radical move from the ECB. The aim would be to drive down real interest rates, allowing government and corporate borrowing at favourable levels to effect a recovery. If this meant higher debt levels, one might expect the euro to weaken against the dollar as a result. While the RBA and BoJ can just go ahead and implement such a policy, the ECB as a supra-national central bank has a host of national political interests to accommodate, not least reticence from Germany and the ‘frugal four’ to further commit to extraordinary monetary policy to help European countries in need (think Italy and chums). There is of course the legal issue of the ECB aiding deficit financing in contravention of the Lisbon Treaty, but given this is Europe, we all know rules are there just to be set aside when the situation demands it.
- Mr Panetta’s speech thus teed-up the March ECB meeting with potentially high expectations not only of a YCC announcement, but potentially Madame Lagarde also telling us what bond yield levels would be suitable. On this front, the meeting was a disappointment – when asked, Madame Lagarde said there is no YCC coming, nor any target rates. Perhaps this will be a back-door policy implemented incrementally and under the guise of a necessary action in the face of what is likely to be another crisis at some point. One expects there might at least be some pushback from Germany et al anyhow. As ever, the official press conference ECB sounded much less dovish than the intra-meeting musings of the (non-German) board members.
- What Madame Lagarde did announce was an increase in PEPP purchases for the next quarter. The size of the ‘envelope’ will remain the same, but the pace of buying will be more vigorous. Perhaps this means €25bn per month up from the recent €12-13bn per month, but she was particularly unclear about how the buying would happen, and what the vectors were that would it on a day-to-day level. Her explanation descended into an almost incomprehensible jibber-jabber of terms like ‘holistic’, ‘multi-faceted’, ‘upstream-and-downstream’ and so on, a master class in obfuscation.
- The announcement though had an immediate effect on the bond market, as can be seen from the graph below of the 10yr Italian BTPS yield. While the short-covering rally was impressive, the market did start to give back its gains when it realised that the overall PEPP was no bigger, and therefore counts as another example of the ECB triumphing in style but not in substance. With US treasury yields again rising on the 12th and 13th March, the question remains whether the ECB is doing enough right now to achieve its policy goals if yields on the other side of the Atlantic continue to rise.
- As ever, the nitty-gritty came out after the ECB meeting and press conference. Reuters headlines republished on Bloomberg alluded to a familiar story of wavering, dissent and compromise, as can be seen below:
*ECB POLICYMAKERS AGREED ON MONTHLY PEPP PURCHASE TARGET AT MEETING: SOURCES
*ECB’S PEPP MONTHLY TARGET LOWER THAN 100 BLN EUROS, WELL ABOVE 60 BLN EUROS PURCHASED IN FEB: SOURCES
*ECB POLICYMAKERS DIFFER ON WHETHER RISE IN YIELDS NEEDS TO BE COMPLETELY UNWOUND: SOURCES
- On other policy matters, the ECB increased their inflation estimate for 2021 (from 1.0% to 1.5%) and 2022 (from 1.1% to 1.2%). But with Italian cities like Rome and Milan re-entering lockdown, and with the European Commission continuing to hide behind accusations of vaccine nationalism as a means of deferring criticism from its own abominable failures to procure a timely supply of vaccines, the risk of another pandemic-related fall in economic activity and therefore further deflationary pressure are extant.
- Economics and markets are to an extent an exercise in the relative (the dollar goes up only if the euro goes down and so on), and it is in Madame Lagarde’s comments on US fiscal policy that Europe’s real problems become more obvious. Understandably, the ECB hadn’t factored in the most recent $1.9tn US stimulus into their current inflation or growth calculations since the measures only passed from Congress to the White House for approval on the day of the ECB press conference.
- Yet Madame Lagarde’s bigging-up Europe’s own pandemic fiscal response could not avoid laying bare the gulf in magnitude between what the US is doing and what is being done at an EU-level in terms of pandemic-relief spending. The US is pushing through $1.9tn of spending at present, and this follows both the $0.9tr Covid-19 Relief Act back in December 2020 as well as the $1.8tn from the original CARES Act earlier in the year. There is speculation that Biden’s infrastructure bill, due in the fall, could be as large as $3tn (albeit spread over four years).
- The EU’s €750m spending package does of course have to be taken in the context of the fiscal support already provided by individual EU member states within their own countries, but it is clearly not in the same league as what the US is doing. Madame Lagarde said there was a “bit of a time lag” in implementation between the EU and the US, and then implied this was somehow part of the policy (remember Hungary holding up the whole process during December?).
- Longer lockdowns due to a failed vaccine policy and a weak recovery from a delayed and underwhelming EU-level fiscal response cannot be hidden forever behind fancy words or ugly bait-and-switch policies such as the one the EC is currently attempting with respect to Britain. One hopes that the Bloomberg headline “*LAGARDE: EU STIMULUS WILL LAG U.S. SUPPORT BECAUSE OF DESIGN” doesn’t come back to haunt her at some stage.
- This is the real question at present – Fabio Panetta can talk about yield-curve control, but policies of this nature are transformational in terms of the reality of burden sharing, deficit financing, tax raising and so on, all of which have been key areas of conflict between EU member states for decades. If the ECB can just declare that YCC is a go, then so be it. But talking the talk and then coming up short will only ever set the Europe up for crisis as eventually the market will test the ECB’s resolve. Mario Draghi got away with just having to say ‘whatever it takes’. Christine Lagarde may well find herself in the unenviable position of having to act this doctrine out, and it is at that point that the ECB’s political and structural weaknesses will be tested out. May be Mr Panetta will be playing Daft Punk’s ‘Human after all’ at that point.