Mario Draghi and the ECB look for more expansionary Euro area fiscal policy

As we travel the journey that is the credit crunch era we pick up some tasty morsels of knowledge along the way. Some were provided by Mario Draghi and the European Central Bank yesterday which announced this.

we decided to launch a new series of quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy.

As ever “the precious” otherwise known as the banks is prioritised ahead of everything else. Also I was asked if this meant the ECB “knew something” to which the answer is simple, if they did then they would have done it last summer. But there was a much bigger pivot.

This happens in a context where the debt to GDP ratio in the eurozone is actually falling.

There was a move towards making a broad hint for more fiscal policy or easing here. Mario also went out of his way to point out that borrowing for Euro area governments is very low.

The simple action of maintaining the stock unchanged in this context actually is a continuous easing because interest rates are pushed downward by this action. You can see this because since we decided in June last year, interest rates have gone down, they keep on going down, the term premium is negative, so conditions are very, very accommodative.

Not only that but he intends to keep it that way.

If you add to this what I’ve just said, it’s the chained element of this, of the horizon over which we’ll carry out purchases to keep the stock unchanged moves together with the forward guidance.

So Mario is pointing out to government’s that if they borrow the ECB will in general be there to help keep borrowing costs low or as we shall see in a bit negative. After all we now live in a world where even Greece can do this.

On Tuesday 5thMarch the Hellenic Republic, rated B1 Moody’s/ B+ S&P/ BB- Fitch/ BH DBRS (stb/ pos/ stb/ pos), priced a €2.5 billion 10-year Government Bond (GGB) due 12th March 2029. The new benchmark carries a coupon of 3.875% and reoffer yield of 3.900%, equating to a reoffer price of 99.796%. Joint bookrunners on the transaction were BNP Paribas, Citi, Credit Suisse, Goldman Sachs Intl, HSBC and J.P. Morgan. ( Note the past behaviour of Goldman Sachs in relation to Greece seems to be no barrier at all to future business…..)

Why so cheap? Well there are two main factors. One is that it is looking to run fiscal surpluses and the other is that whilst it is not in the ECB QE programme it may well be in a future one and that is looking more likely by the day. As to the economy it is with a heavy heart that I point out this which speaks for itself.

The available seasonally adjusted data
indicate that in the 4 th quarter of 2018 the Gross Domestic
Product (GDP) in volume terms decreased by 0.1% in comparison with the 3rd quarter of 2018,
while in comparison with the 4th quarter of 2017, it increased by 1.6%.

Mario also gave us a reminder of the scale of Euro area bond buying so far.

Just to give you an idea, the balance sheet of the ECB is about 42 – 43% of the eurozone GDP. The Fed is about half of it now. In order to keep this stock unchanged, we continue purchasing something in the order of €20 billion a month of bonds.

Here are more hints on the subject with also I think a nod to his home country Italy.

Regarding fiscal policies, the mildly expansionary euro area fiscal stance and the operation of automatic stabilisers are providing support to economic activity. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should continue to increase efforts to achieve a more growth-friendly composition of public finances.

Bond Yields

Let us start with the largest Euro area economy with is Germany. We saw bond prices rise and yields fall quite quickly in response to this. The German ten-year yield fell from 0.12% to 0.06% which makes us wonder if we may see another spell of it going negative like it did in the summer and autumn of 2016? It would not take a lot as the nine-year yield is now -0.1%.

So Germany can borrow essentially for nothing should it so choose over a ten-year horizon. That is in nominal terms and if we see inflation in this period then the real cost will be negative. Yet if you read through the cheerleading it is aiming for a fiscal surplus.

The general government budget surplus
will fall from roughly 1½% of GDP in
2018 to roughly 1% of GDP in 2019.
In 2019 and subsequent years, a fiscal
impact will be made in particular by
the priority measures contained in the
Coalition Agreement and other measures.
The implementation of these measures
will reduce the federal budget surplus. ( Draft Budget October 2018).

Although those numbers are already suffering from the TalkTalk critique and on that subject RIP Mark Hollis.

Baby, life’s what you make it
Celebrate it
Anticipate it
Yesterday’s faded
Nothing can change it
Life’s what you make it

Why? Well we have indeed moved on since this as the German economy shrank in the second half of 2018.

which forecasts a real growth rate of 1.8% in both 2018 and
2019. This means that Germany’s economy is expected to keep growing at a pace that slightly exceeds potential output.

Also if we look around we see that European supranational bodies can borrow very cheaply too. Maybe not at German rates but often pretty near. After considering that now let us return to Mario Draghi yesterday.

Now, Philip Lane is an excellent acquisition for the ECB but we are not going to ask him about this Eurobond thing. The Eurobond is again not something that the ECB can force or just decide about; again it’s an inherently political decision. And of course this doesn’t detract at all from the argument that it’s absolutely rational to have a safe asset at European level.

We have seen the Eurobond case made many times and so far Germany keeps torpedoing it, but we also know that in Europe these sort of things tend to happen eventually after of course a forest of denials and rejections.

Comment

We have seen quite a few phases now of the Euro area crisis. For a while it looked like “escape velocity” had been achieved but now we see to be facing many of the same problems with quarterly economic growth having gone 0.1%, 0.2% and looking like being around 0.2% in the first quarter of this year. Although he tried to downplay such thoughts yesterday it is hard not to think of this from Mario Draghi last November.

 I’ll be briefer than I would like to be, but certainly especially in some parts of this period of time, QE has been the only driver of this recovery.

Ironically he is avoiding the subject just as the evidence is pointing that way. For the moment monetary policy is to coin a phrase “maxxed out” although in this instance it is more timing than not being able to do more, as it would be an embarrassing U-Turn. So for now if Euro area government’s and especially Germany were to embark on a fiscal stimulus the ECB would turn its blind eye towards it I think.