The ECB “taper” meets “To infinity! And beyond!”

Yesterday was central banker day when we heard from Mark Carney of the Bank of England, Mario Draghi of the ECB and Janet Yellen of the US Federal Reserve. I covered the woes of Governor Carney yesterday and note that even that keen supporter of him Bloomberg is now pointing out that he is losing the debate. As it happened Janet Yellen was also giving a speech in London and gave a huge hostage to fortune.

Yellen today: “Don’t see another crisis in our lifetimes” Yellen May 2016: “We Didn’t See The Financial Crisis Coming” ( @Stalingrad_Poor )

Let us hope she is in good health and if you really wanted to embarrass her you would look at what she was saying in 2007/08. However the most significant speech came at the best location as the ECB has decamped to its summer break, excuse me central banking forum, at the Portuguese resort of Sintra.

Mario Draghi

As President Draghi enjoyed his morning espresso before giving his keynote speech he will have let out a sigh of relief that it was not about banking supervision. After all the bailout of the Veneto Banks in Italy would have come up and people might have asked on whose watch as Governor of the Bank of Italy the problems built up? Even worse one of the young economists invited might have wondered why the legal infrastructure covering the Italian banking sector is nicknamed the “Draghi Laws”?

However even in the area of monetary policy there are problems to be faced as I pointed out on the 13th of March.

It too is in a zone where ch-ch-changes are ahead. I have written several times already explaining that with inflation pretty much on target and economic growth having improved its rate of expansion of its balance sheet looks far to high even at the 60 billion Euros a month due in April.

Indeed on the 26th of May I noted that Mario himself had implicitly admitted as much.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

That simply does not go with an official deposit rate of -0.4% and 60 billion Euros a month of Quantitative Easing. Policy is expansionary in what is in Euro area terms a boom.

This was the first problem that Mario faced which is how to bask in the success of economic growth whilst avoiding the obvious counterpoint that policy is now wrong. He did this partly by indulging in an international comparison.

since January 2015 – that is, following the announcement of the expanded asset purchase programme (APP) – GDP
has grown by 3.6% in the euro area. That is a higher growth rate than in same period following QE1 or QE2 in the United States, and a percentage point lower than the period after QE3. Employment in the euro area has also risen by more than four million since we announced the expanded APP, comparable with both QE2 and QE3 in the US, and considerably higher than QE1.

You may note that Mario is picking his own variables meaning that unemployment for example is omitted as are differences of timing and circumstance. But on this road we got the section which had an immediate impact on financial markets.

The threat of deflation is gone and reflationary forces are at play.

So we got an implicit admittal that policy is pro-cyclical or if you prefer wrong. A reduction in monthly QE purchases of 20 billion a month is dwarfed by the change in circumstances. But we have to be told something is happening so there was this.

This more favourable balance of risks has been already reflected in our monetary policy stance, via the adjustments we have made to our forward guidance.

You have my permission to laugh at this point! If he went out into the streets of Sintra I wonder how many would know who he is let alone be running their lives to the tune of his Forward Guidance!? Whilst his Forward Guidance has not been quite the disaster of Mark Carney the sentence below shows a misfire.

This illustrates that core inflation does not
always give us a clear reading of underlying inflation dynamics.

The truth is as I have argued all along that there was no deflation threat in terms of a downwards spiral for inflation because it was driven by this.

Oil-related base effects are also the main driver of the considerable volatility in headline inflation that we have seen, and will be seeing, in the euro area………. As a result, in the first quarter of 2017, oil-sensitive items  were still holding back core inflation.

I guess the many parts of the media which have copy and pasted the core inflation/deflation theme will be hoping that their readers have a bout of amnesia. Or to put it another way that Mario has set up a straw (wo)man below.

What is clear is that our monetary policy measures have been successful in avoiding a deflationary spiral and securing the anchoring of inflation expectations.

Actually if you look elsewhere in his speech you will see that if you consider all the effort put in that in fact his policies had a relatively minor impact.

Between 2016 and 2019 we estimate that our monetary policy will have lifted inflation by 1.7 percentage points,

So it took a balance sheet of 4.2 trillion Euros ( and of course rising as this goes to 2019) to get that? You can look at the current flow of 60 billion a month which makes it look a little better but it is not a lot of bang for your Euro.

Market Movements

There was a clear response to the mention of the word “reflationary” as the Euro rose strongly. It rose above 1.13 to the US Dollar as it continued the stronger  phase we have been seeing in 2017 as it opened the year more like 1.04.  Also government bond yields rose although the media reports of “jumps” made me smile as I noted that the German ten-year yield was only 0.4% and the two-year was -0.57%! Remember when the ECB promised it was fixing the issue of demand for German bonds?


On the surface this is a triumph for Forward Guidance as Mario’s speech tightens monetary policy via higher bond yields and a higher value for the Euro on the foreign exchanges. Yet if we go back to March 2014 he himself pointed out the flaw in this.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

You see the effective or trade-weighted index dipped to 93.5 in the middle of April but was 97.2 at yesterday’s close. If we note that Mario is not achieving his inflation target and may be moving away from it we get food for thought.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

So as the markets assume what might be called “tapering” ( in terms of monthly QE purchases) or “normalisation” in terms of interest-rates we can look further ahead and wonder if “To infinity! And Beyond!” will win? After all if the economy slows later this year  and inflation remains below target ………

There are two intangible factors here. Firstly the path of inflation these days depends mostly in the price of crude oil. Secondly whilst I avoid politics like the plague it is true that we will find out more about what the ECB really intends once this years major elections are done and dusted as the word “independent” gets another modification in my financial lexicon for these times



13 thoughts on “The ECB “taper” meets “To infinity! And beyond!”

  1. 60 billion a month appears to be going to the Banks, not peoples pockets

    so it will have little effect on GDP apart from inflated assets to prop the Banks up.

    Crazy eh ?


  2. It’s amazing how they can keep a straight face when they start talking about how inherently stable it is to for the ECB to have a E4.2 tn balance sheet and for two year bunds to be at a negative level when inflation is running much higher.

    I’m not sure what their response to a major debt crisis will be?

    • Hi Dutch

      Well it seems that a single speech has got them in such a muddle they have needed to deploy a reverse ferret. From the FT.

      “Markets whipsawed on Wednesday after senior officials at the European Central Bank said investors had misunderstood an upbeat speech by Mario Draghi as heralding the end of its asset purchase programme……. Senior eurozone central bankers maintained that markets had misunderstood their more optimistic tone on the economy, indicating that they are further away than investors think from ending their quantitative easing programme.”

      Not inspiring is it?

      • I think that
        1. The speeches are made either stupidly or to test the water in trend of market reaction
        2. The clarifications are a reflection of disliking the reaction and so reversing the first speech
        3. That our great leaders have absolutely no idea what to do about getting out of the QE mess

  3. And the euro, which for years all the “experts” and fx strategists said would be the weakest of the majors or even collapse are now very quiet as it is roaring back.
    Just goes to show that William Goldman’s double negative, off the cuff comment “nobody knows anything” regarding what makes a great movie, certainly applies to forex as well.

    But perhaps there are a great number of very powerful people very keen for the EU to continue and are willing and able to provide support for the currency and the regions stockmarkets?

    • Hi Kevin

      My old employer Deutsche Bank was in the van of this as its previous target for the Euro versus the US Dollar of 1.03 was replaced with 1.16. As is the way of such things the Euro then dipped. Whilst we are discussing reverse indicators the most reliable of recent times has apparently just said this.

      “There’s a real problem out there in the crude oil market, Dennis Gartman told CNBC.
      He believes the current rally is nothing but a “dead cat bounce.”
      Long term, he is still convinced crude is in a bear market.”

  4. Hi Shaun
    A very interesting blog indeed.
    Recently Mark Carney said that now was not the time for rate rises and this was endorsed by Jon Cunlffe.
    Today Mr Carney has made an ambiguous statement about rate rises may become necessary.
    All of these comments are no help to anyone.Business and home buyers etc will be bamboozled yet again.
    I see Ms Flanders is on the move again.

    • Hi Midge

      I did not know about the move for Stephanie Flanders so thanks for the heads up. For those who like me who had missed this here is the announcement.

      “Stephanie Flanders, the former BBC economics editor who left to join JPMorgan Asset Management in 2013, is to lead a new economics desk at Bloomberg.”

      I had heard rumours of some ahem dissent at JPM…..

  5. Politicians and Central Bankers who needs them – well this current load. Guess who suffers when they get it wrong – as they do often. Back to the usual cop out – Not me Guv I was on holiday

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