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.

What to expect next week ? (July 8 – July 14, 2019)

Highlights

  • External trade for Germany is the statistics I will focus on this week (July 8). Since the beginning of the year, real exports are slowing down as a consequence of the trade war. Expectations are negative and this is a source of concern for the German growth momentum. The German government may have, in coming weeks, an opportunity to boost domestic demand to cushion this disruption.
  • The Chinese external trade will also be a major indicator (July 12) as a measure of the trade war impact.
  • The German industrial production index will also show a slowdown in May (July 8). This would be consistent with expectations on its external trade and with corporate surveys that reflect pessimism.
    The other point to mention here is that the UK industrial production will show a downward trend (July 11). This would be consistent with the Markit index for the manufacturing sector. In May the Markit synthetic index was at 49.4 (from 53.1 in April).
  • The US inflation rate for June (July 11) will slow as seen in European inflation rates for June (flash estimates) while the Chinese will remain strong (2.7% in May) as food price (pork price precisely) will continue to push up the price index.
  • Financial Stability Report by the Bank of England (July 11 at 1130 CET), Minutes of the last FOMC meeting (June 18-19) on July 10 (2000 CET)  and Minutes of the last ECB meeting (June 5-6) on monetary policy (July 11 at 1330 CET)

The document is available here NextWeek-July8-July14-2019

 

ECB: How to burn ammunition for nothing

In Sintra, at the ECB seminar, Mario Draghi stressed the risk on growth and the difficulties of converging to the inflation target (close but below 2%).

If additional risks materialize then the ECB could reduce its rates and restart an asset purchase procedure. The idea is to take back and accentuate what has been the success of the ECB since 2013. (Low rate = less incentive to defer its wealth over time given the low return associated with it.it has been strong support for a stronger momentum for the domestic demand)

At the same time, Draghi called for an active economic policy. On this point, the failure to implement a euro area budget reflects non-homogeneous behavior in the euro zone. As a consequence there will be no common fiscal policy in the euro area. One can not therefore imagine a two-component euro-zone policy.

A major rule of the theory of economic policy is that it requires as many instruments as objectives. There are two objectives (growth and inflation) and one instrument, monetary policy.

This will not work especially with a series of negative external shocks. In 2016/2017, monetary policy benefited from a favorable international context even if fiscal policy was not active. Today, the environment is no longer as buoyant and the absence of fiscal policy will make it difficult to cushion external shocks. The ECB will act alone and becoming more accommodating it will burn ammunition for a poor result.

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

The Euro zone slows sharply in March

The publication March’s Markit indices confirms the downward pressure on activity in the manufacturing sector. The leading indices published for the Euro zone, Germany and France, on March 22, have been revised downward. This is never a very good signal as to the strength of the activity. This revision was marginal in the Euro zone (from 47.6 to 47.5) and in France (49.8 to 49.7) but more marked in Germany from 44.7 to 44.1. This latter has not been so low since July 2012.
For the Euro zone, the index has not been as low since June 2013 but at the time the movement was bullish while here it reflects a deterioration of the activity.
For the other two major countries, Spain and Italy, there is a slight rebound in Spain from 49.9 in February to 50.9 in March, but the Italian situation continues to deteriorate, from 47.7 to 47.4.

A good explanation is the pace of international trade. Germany is frankly penalized by the contraction of trade due to an openness rate higher than 44% of GDP. Any shock on world trade has an immediate impact on it.
More generally, because of the intensive trade between countries of the zone, any external shock is amplified by a contagion effect and penalizes the activity of all. This had been a very positive uptrend in 2017 but is declining today.
Germany saw its export orders revised downwards compared to the March estimate (38.9 vs. 39.5 initially). For France, the figure is unchanged.

The proactive economic policy of the Eurozone can only be seen on monetary side with a very accommodative policy but it cannot go further in that direction to limit the impact and the spillover effect of the shock. Except for a sudden and unexpected reversal of world trade, the trend in the Euro zone is here to stay. It should be possible to support domestic demand for this through budgetary means. This is not the current mood at the European level even if France plays constrained by the social unrest