ECB accentuates financial repression for an extended period

The ECB has lowered its deposit rate by 10bp to -0.5% and will keep all of its rates at the current level or lower until inflation converges to 2%. In the ECB’s forecasts, inflation will be 1.5% in 2021. Therefore, the short-term rates will remain at the current level until at least 2022.
The ECB has also decided to resume it Quantitative Easing program (QE) by 20 billions euro from November the 1st.. This has already resulted in a spectacular decline of the 10y Italian rate.
This QE measure will accentuate financial repression. The aim is to push the entire rate structure for all countries in negative territory, Italy included. It can last beyond what we imagine. The purpose of financial repression is to reduce the incentive to save and to increase the incentive to spend to curb activity on the upside.
The wish of the ECB is that fiscal policy will change and be more active so that the measures taken are more effective and faster. However, he has been repeating this since the beginning of his term.
The ECB will reduce its deposit rate to -0.5% with the adoption of a system that will adjust this rate according to the type of reserve (tiering). Excess reserves will be paid at 0% and the rest at -0.5%.
The TLTRO is extended to 3 years and the rate on each transaction will be the main refinancing rate over the remaining time of this TLTRO tranche.
Given the length of the TLTRO and the expectations mentioned above on inflation, the applicable rate could be on average the deposit rate over the duration of the transaction for banks whose loans exceed the loan reference defined by the ECB. This means that for banks with excess liquidity, they may have an interest in lending and placing their loans in excess reserves. This will strengthen the banking sector.

The financial repression put in place by the ECB implies that interest rates for all maturities and for all countries are low and negative for a very very long time.
Economic players have changed their behavior when interest rates dropped to 0 or negative. But this change is now over. Behavior’s change will be marginal. The upward macroeconomic impact will therefore be very limited.
Moreover, the ECB’s signal could also be interpreted as reflecting a particularly degraded situation, thus raising concern for households and companies. Th risk is that signal may, at the end, have a negative effect on the economy. Will the stronger banking sector be enough to counteract this effect? It’s an unknown today.
Growth forecasts are revised downwards to 1.1% in 2019, 1.2% in 2020 and 1.4% in 2021. An external shock could tip the Eurozone into recession. For now, the ECB considers this probability to be very low.
This nonetheless reinforces the need for an effective and proactive fiscal policy to get out of the current liquidity trap whether or not there is a recession.
Given the lack of willingness of governments to have a coordinated fiscal policy, the position of Draghi is associated with a strong bet on the future at the risk of becoming wishful thinking.
Good luck Christine Lagarde

What to expect next week ? (September 9 – September 15, 2019)

Highlights

> The ECB meeting will be the most important event of the week. Bazooka measures are expected with lower deposit rate (associated with a tiering depending on the size of the bank) and the resumption of the Quantitative Easing Program.
> The lower deposit rate with tiering will help the banking system. The EONIA may even be higher than what is currently seen.
The QE program will push down all interest rates and reinforce financial repression
We do not expect strong impact on the Eurozone growth momentum or on its inflation.

> External trade in Germany will highlight the impact of the world trade lower momentum. Lower exports have pushed the German GDP change in negative territory during the second quarter. An extended slowdown of the world trade (as expected when we look at the worldwide lower exports orders in the Markit survey) would push Germany in recession.

> Retail sales in the US for August (13) are the last good numbers expected. In September, tariffs on Chinese consumer goods imported in the US will have a negative impact on consumers’ behavior.
> JOLTS (10) will show the probable change in the US labor market trend
> The UK economy  had a negative change figure in the second quarter. This will have an impact of the labor market (10) for July.

The detailed document can be read here
NextWeek-September9-September15-2019

ECB will reduce its rates as expected

The ECB will cut interest rates in September with probably a differentiated deposit rate regime depending on the amount of deposits. It is considering the resumption of asset purchases.

The analysis I was doing this morning always seems correct to me (see here).
I will add another remark nonetheless. The risk of recession appears low according to Draghi. What will the ECB do in the event of a recession? It will be necessary at all costs a proactive fiscal policy to get out. That’s a risky bet

A more accommodative ECB, ok but for what ?

Mario Draghi will most likely announce, for September, measures for a more accommodating monetary policy. A possible rate cut and the resumption of QE would lead to an increase in financial repression. Debt issuers will benefit to the detriment of the savers. This will give additional margins to euro area governments since they will be even less constrained by any financial element.

Four questions

1- Will household behavior be affected? The drain on their savings will only be gradual via the decline in bond yields (I am thinking here of life insurance for example). Do not count on an acceleration of consumption. This has already occurred when the refi rate has fallen to 0%.

2- The rate on corporate bonds will remain very low especially if the QE includes purchases of companies’ securities. The risk is to have more fragile financial structures because the debt will not stop.

3- The financial repression favors governments which appropriates an additional part of the savings. The question is: what for? If it is to finance operating expenses then the efficiency will be zero and the monetary measure will only increase the discomfort. This means that expenditures must be on capital expenditures to expect the convergence to a higher growth trajectory. In this case, monetary policy will have been effective. This brings back Olivier Blanchard and Martin Uribe’s discussions.

4- These questions bring us once again to fiscal policy and its effectiveness. Draghi discusses this issue at each press conference. Eurozone fiscal policy will not exist for lack of support and not just from Germans.

This means that to be effective the measures announced by the ECB will have to reflect a strong fiscal awareness of all the countries in the zone. One can be dubious unless Germany enters a recession. In this case the purse strings would relax.

The ECB monetary policy is too tight

Mario Draghi said the ECB was ready to act if necessary.

But there is something I don’t understand: the ECB revised down its forecasts for growth and for inflation for this year and the 2 years to come. Growth will barely converge to 1.4% in 2021 and the inflation rate is expected to be at 1.6% for the same year(way below the ECB target).

Can it be satysfying ? No, this level of forecasts are too low.

This means that the Euro Area has not been able to cushion the external negative shock. If there is still leeway on monetary policy side this means that the current stance is too tight. Today’s forward guidance on future monetary policy measures is not sufficient to reverse the trend. Need more