Are “open mouth operations” the main policy weapon of the ECB ?

The European Central Bank has spent most of the credit crunch era between a rock and a hard place. If anything the rocks are getting tougher and the hard place harder. This was supposed to be the year of recovery for the Euro area with economic growth expected of 1.4% to be followed by better years. Instead the latest Eurostat GDP (Gross Domestic Product) estimate was for annual growth of 0.8% and quarterly growth of 0.2%. In the larger scheme of things that is not such an enormous divergence but there are two additional factors at play. Firstly whilst Spain has been a bright spot, Germany is showing signs of struggling, France is relying on government spending to show slow economic growth and Italy has remained well Italy. So the sunny uplands of 2015 suddenly do not look quite so sunny. Secondly the Euro area is beginning to establish a trend of weak nascent economic growth at best.

What about inflation?

This is something of a rod that the ECB has created for its own back. Let me explain why. The situation was illustrated by the valedictory speech of the previous ECB President Jean-Claude Trichet.

And, as I just said, over the first twelve years we have delivered average yearly inflation at the level of less than 2%: it is a better result than the previous national currencies over the last 50 years, including the Deutsche Mark. Here in Aachen, I can say, the promise “stark wie die Mark” has been fully respected.

In the version I watched he defined the performance as 1.97% in the manner of someone giving themselves 10/10! In itself this may not have created such a problem as for example inflation targeting does impose a discipline on central banks something sorely missing right now elsewhere. But 2014 has seen a catch in this and that is the way that the ECB has made mistakes in its presentation of this.

Firstly  the ECB has consistently underestimated the scale of disinflationary pressure in 2014. This was highlighted again at last weeks press conference and the emphasis is mine.

at the time the December 2014 Eurosystem staff macroeconomic projections for the euro area were finalised, annual HICP inflation was foreseen to reach 0.5% in 2014, 0.7% in 2015 and 1.3% in 2016. In comparison with the September 2014 ECB staff macroeconomic projections, they have been revised significantly downwards.

This is just one example of how the ECB has ended up like a dog chasing its tail on this subject but dogs tire of this game whereas the ECB continues to go round and round. This to my mind has been driven by the fly in the ointment which is this.

Monetary policy is focused on maintaining price stability over the medium term

You see this is an outright lie as it is set at inflation stability at 2% per annum whereas pure price stability would be unchanged prices. This is a common central bank Jedi Mind Trick but as both consumer inflation and inflation expectations have fallen in the Euro area in 2014 the ECB has sunk into a quagmire partly of its own making. As of last Thursday it continued to do so.

All of our monetary policy measures are geared towards underpinning the firm anchoring of medium to long-term inflation expectations, in line with our aim of achieving inflation rates below, but close to, 2%, and contribute to a return of inflation rates towards that level.

Hands up anybody who believes that inflationary expectations are underpinned in the Euro area right now? No I did not think so….

What about the oil price fall?

This is a good news story for the Euro area as I discussed on the 28th of November . It will have a reflationary impact on the various economies there and one effect is already being felt according to Mario Draghi.

Just to give you a very rough estimate, our import bill of energy, of oil, fell about €10 billion between the second and the fourth quarter of this year. Now, that is about 0.2% of nominal GDP in that period. That is not going to be the final impact, because Europe also exports oil, but the net is unambiguously positive.


If we skip the troubling thought that this may have been the growth measured by Eurostat which otherwise would have been zero on a quarterly basis we see that going forwards there will be other positive impacts too. We also know that as I type this the situation is still developing as the price of a barrel of Brent Crude Oil has continued to fall (warning oil prices can plummet as well as fall…..) and is now just above US $66. So at this stage of the saga we have an improvement in growth prospects and we can remind ourselves of a past US television series.

Sunday, Monday, Happy Days,
Tuesday, Wednesday, Happy Days,
Thursday, Friday, Happy Days,
Saturday, what a day,
Groovin’ all week with you.


Back to inflation

The catch is that the ECB has continually promised to return inflation to its target and the fall in oil prices will push it below a significant barrier if they stay here. If we return to the ECB press conference last Thursday we were told this.

We estimate the direct and indirect effects on HICP inflation are going to be 0.4% in 2015 and 0.1% in 2016. That is very important to keep in mind because it could alter the profile of inflation rates over the coming months, especially in the next few months.


Could?! If we factor in the fact that oil prices have continued to fall since then by around US $4 then a 0% consumer inflation print is marching over the horizon. Indeed we may have negative consumer inflation to set against negative interest -rates.

ECB policy moves

We have had a torrent of open mouth operations as highlighted here.

Taken together, our measures will have a sizeable impact on our balance sheet, which is intended to move towards the dimensions it had at the beginning of 2012.


This is the trillion Euro promise which keeps echoing around the walls of the ECB’s shiny new building. However this week has seen yet more evidence of a different reality.

Covered bonds and ABS cumulatively purchased and settled as at 05/12/2014: 20,927 million and 601 million respectively.


After all the hyperbole from Mario Draghi about ABS (Asset Backed Securities) purchases the first week’s effort of 368 million Euros was paltry. Well it is now hard to know whether to laugh or cry at the subsequent 233 million Euros. After all when did central banks return to counting in millions?

To QE or not to QE?

By this I mean purchases of sovereign bonds as the threshold for private-sector bonds went a long time ago when the ECB first purchased covered bonds in July 2009. There are a myriad of problems here before we even get to the issue of whether Mario Draghi can get a majority vote in favour?

Firstly as the record of QE (Quantitative Easing) is patchy at best will it work? Even worse the part which seems to have given a push to the United States was most similar to the covered bond programme which the ECB has already tried twice. Third time lucky?

Next we have the issue of the programme being backed by 18 (soon to be 19) national treasuries rather than a single one. Just at a time when places such as Italy are seeing an increasing number of voices calling for a Euro exit. What could go wrong?

Then we have the issue of bond yields being so low anyway with even the laggard in this area that is Portugal having a ten-year benchmark yield of 2.81%. On that road the benefits of sovereign QE are already being experienced as we see that the Frenchman in the film the Matrix Revolutions did not understand “Cause and Effect” as well as he thought he did.


On today’s journey we see that the trillion Euro promise has got no nearer to being fulfilled. It could be something of a mythical beast in the same way that Mario Draghi promised Outright Monetary Transactions but never used them. OMTs have been hailed by hedge funds and it is true that hedge funds made a lot of money out of the promise. But the real economy has been quite a different matter as I would not be writing this article if it had also responded. So we could be seeing another central banking Jedi Mind Trick.

If you wish for a glass half-full then they are doing this because the oil stimulus will add to the existing monetary stimulus and provide an uptick in economic growth as we move into 2015. The dark side fears are that the oil price fall is associated with a weakening level of demand so that we will have dropped before we grow again.

Maybe the TLTRO (Targeted Long=Term Refinancing Operation) on Thursday will help but the last one disappointed and all I see on my Twitter timeline are lower and lower estimated impacts for this one. The falling value of the Euro has made a far bigger impact on the situation and that of course has mostly been the mirror image of US Dollar strength.

As I look at the state of English cricket right now I wonder if it is the acronym ECB which is part of the problem!


10 thoughts on “Are “open mouth operations” the main policy weapon of the ECB ?

  1. The falling value of the Euro (except against Sterling for some strange reason) is the one thing that actually appears to help Euroland as confirmed by an uptick in Greek exports. It puzzles me that the ECB doesn’t go all out to drop the value as much as they could. Everything else appears to be smoke and mirrors and ineffective.

    • Hi Pavlaki
      In essence the two main movers for the Euro area economy are the fall in the oil price and the dropping Euro which is mostly US Dollar strength. As to the ECB itself it has occassionally tried to talk the Euro down but it has not shaken off the ersatz/proxy Dm effect. Of course the Euro has risen against the Yen (until today) and the Ruble.

      So the situation is like a boat adrift without a sail or an engine as you say.

  2. ECB Chief Executive Giles Clarke would make a terrible replacement for Mario. They really need a Geoffrey Boycott figure to keep things on t’rack…

  3. Shaun,
    My reading today is that Nowatony has made his position more accomodative towards Q.E. and this will start the balance swinging to a stong majority. You refer to the Italians starting a heretical theme against the Euro. We all know that a “baby” is need to repair the “relationship”, to use that oft used family comparison. I can’t think of anythinig better to meld and shackle the warring parties than a shared punch-bowl. Yes, lets get printing those artifical notes, then no-one can escape the unholy alliance because the local governments will be falling over themselves to spend the readies on their pet projects/indulgences. Now remind me, after our £375Bn what long-lasting outcome did we get?

    I think the European output and GDP numbers will subtantially worsen in deep winter and the politicos (except Germany) will jointly push the button. We shall see…

    • And what if Germany won’t play ball? What credibility will it have? What if the Karlsrhur constitutional court states it’s not legal? It seems to me Ange and Herr Schauble are doing a duet of the old Meatloaf number; “I would do anything for love (but I won’t do that!)”.

      • Andy, I think that they will have to be “Europeans” and stop imposing their national “rules” on everyone else. It is a surety now for 2015, significant money printing, they’ll have to copy the US and UK who “appear” to have benefitted.

  4. Hallo Shaun,
    An interesting piece. My feeling is that Mario is trying to place public pressure on the Germans to cave in and agree QE. I’ve no idea if it will work – the public pressure that is, the QE is obviously doomed but EZ money growth picked up in Spring 14 and I am revising earlier predictions about a EZ pick up in Spring 2015 and bringing it forward to now. I think it’s already started thanks to a further push from oil price which will release more money for consumer expenditure which, if they do spend, should stop inflation going negative.

    There’s also the US $ strength to consider, which I think can only strengthen more as the Fed is doing most things right and there is no reason yet to change course, other than delaying raising rates due to the shenanigans of BOJ, BOC and ECB who are threatening QE and as a result weaken the Euro and increase exports (which is desperately needed). Mario should sit on his hands for the moment and let things take their course.

    • Hi Noo2

      I agree that the ECB has got itself out of phase with events. However as last December the monh on month inflation rate was 0.4% then assuming the oil price remains around here there will be substantial downwads pressure. Thus a zero or negative year on year print is a risk. Should the headlines scream deflation as they would in such a scenario then Mario may have to supply his trillion Euros whether the economy needs it or not.

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