Where will Christine Lagarde lead the ECB?

We find ourselves in a new era for monetary policy in the Euro area and it comes in two forms. The first is the way that the pause in adding to expansionary monetary policy which lasted for all of ten months is now over. It has been replaced by an extra 20 billion Euros a month of QE bond purchases and tiering of interest-rates for the banking sector. The next is the way that technocrats have been replaced by politicians as we note that not only is the President Christine Lagarde the former Finance Minister of France the Vice-President Luis de Guindos is the former Economy Minister of Spain. So much for the much vaunted independence!

Monetary Policy

In addition to the new deposit rate of -0.5% Mario Draghi’s last policy move was this.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP), i.e. the public sector purchase programme (PSPP), the asset-backed securities purchase programme (ABSPP), the third covered bond purchase programme (CBPP3) and the corporate sector purchase programme (CSPP), at a monthly pace of €20 billion as from 1 November 2019.

It is the online equivalent of a bit of a mouthful and has had a by now familiar effect in financial markets. Regular readers will recall mt pointing out that the main impact comes before it happens and we have seen that again. If we use the German ten-year yield as our measure we saw it fall below -0.7% in August and September as hopes/expectations of QE rose but the reality of it now sees the yield at -0.3%. So bond markets have retreated after the pre-announcement hype.

As to reducing the deposit rate from -0.4% to -0.5% was hardly going to have much impact so let us move into the tiering which is a way of helping the banks as described by @fwred of Bank Pictet.

reduces the cost of negative rates from €8.7bn to €5.0bn (though it will increase in 2020) – creates €35bn in arbitrage opportunities for Italian banks – no signs of major disruption in repo, so far.

Oh and there will be another liquidity effort or TLTRO-III but that will be in December.

There is of course ebb and flow in financial markets but as we stand things have gone backwards except for the banks.

The Euro

If we switch to that we need to note first that the economics 101 theory that QE leads to currency depreciation has had at best a patchy credit crunch era. But over this phase we see that the Euro has weakened as its trade weighted index was 98.7 in mid-August compared to the 96.9 of yesterday. As ever the issue is complex because for example my home country the UK has seen a better phase for the UK Pound £ moving from 0.93 in early August to 0.86 now if we quote it the financial market way.

The Economy

The economic growth situation has been this.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 1.1% in the euro area in the third quarter of 2019 ( Eurostat)

As you can see annual economic growth has weakened and if we update to this morning we were told this by the Markit PMI business survey.

The IHS Markit Eurozone PMI® Composite
Output Index improved during October, but
remained close to the crucial 50.0 no-change mark.
The index recorded 50.6, up from 50.1 in
September and slightly better than the earlier flash
reading of 50.2, but still signalling a rate of growth
that was amongst the weakest seen in the past six and-a-half years.

As you can see there was a small improvement but that relies on you believing that the measure is accurate to 0.5 in reality. The Markit conclusion was this.

The euro area remained close to stagnation in
October, with falling order books suggesting that
risks are currently tilted towards contraction in the
fourth quarter. While the October PMI is consistent
with quarterly GDP rising by 0.1%, the forward looking data points to a possible decline in economic output in the fourth quarter.

As you can see this is not entirely hopeful because the possible 0.1% GDP growth looks set to disappear raising the risk of a contraction.

I doubt anyone will be surprised to see the sectoral breakdown.

There remained a divergence between the
manufacturing and service sectors during October.
Whereas manufacturing firms recorded a ninth
successive month of declining production, service
sector companies indicated further growth, albeit at
the second-weakest rate since January.

Retail Sales

According to Eurostat there was some good news here.

In September 2019 compared with August 2019, the seasonally adjusted volume of retail trade increased by 0.1% in the euro area (EA19). In September 2019 compared with September 2018, the calendar adjusted retail sales index increased by 3.1% in the euro area .

The geographical position is rather widespread from the 5.2% annual growth of Ireland to the -2.7% of Slovakia. This is an area which has been influenced by the better money supply growth figures of 2019. This has been an awkward area as they have often been a really good indicator but have been swamped this year by the trade and motor industry problems which are outside their orbit. Also the better picture may now be fading.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 7.9% in September from 8.5% in August.

In theory it should rally due to the monthly QE but in reality it is far from that simple as M1 growth picked up after the last phase of QE stopped.


As you can see there are a lot of challenges on the horizon for the ECB just at the time its leadership is most ill-equipped to deal with them. A sign of that was this from President Lagarde back in September.

“The ECB is supporting the development of such a taxonomy,” Lagarde said. “Once it is agreed, in my view it will facilitate the incorporation of environmental considerations in central bank portfolios.” ( Politico EU)

Fans of climate change policies should be upset if they look at the success record of central banks and indeed Madame Lagarde. More prosaically the ECB would be like a bull in a China shop assuming it can define them in the first place.

More recently President Lagarde made what even for her was an extraordinary speech.

There are few who have done so much for Europe, over so long a period, as you, Wolfgang.

This was for the former German Finance Minister Wolfgang Schauble. Was it the ongoing German current account surplus she was cheering or the heading towards a fiscal one as well? Perhaps the punishment regime for Greece?

As to the banks there were some odd rumours circulating yesterday about Deutsche Bank. We know it has a long list of problems but as far as I can tell it was no more bankrupt yesterday than a month ago. Yet there was this.

Mind you perhaps this is why Germany seems to be warming towards a European banking union…..

10 thoughts on “Where will Christine Lagarde lead the ECB?

  1. Hello Shaun

    re ” perhaps this is why Germany seems to be warming towards a European banking union”

    I would be seriously concerned if I was a German, the PIIGS have not been careful . There is a whole lot more hidden debt issues ……


    • Hi Forbin

      The Deutsche Bank rumours have not gone away although the share price was up 2% at one point today before closing pretty much unchanged at 6.93 Euros. But yes you are right as the Italians for example would want to put Monte Paschi at least in the pot if DB was to be bailed out.

  2. There are always rumours around certain banks,some are just a lot more persistent than others.

    I remember watching the early work of Mark Hanson back in early to mid 08 when he called out Lehman……and yet there were people at the top of banking pyramids the world over who said noone saw it coming……………

    There are bubbles out there and without delving too much into any one, it’s worth considering the collateral the other side of the loan-commercial real estate particularly where footfall is declining year on year, junk bond loans where companies have been borrowing short and investing long in illiquid assets,residential real estate the western world over,car loans…I could go on.

    Safe to say when this global ponzi pops we’ll get the normal parade of players claiming this is an international problem, a conflagration of utterly random unconnected events etc.

    • Hi Dutch

      The sad reality is that many of those who are supposedly employed to protect us are in fact there to protect the financial industry and to claim “nobody saw it coming” should things go wrong. I remember that being one of the components of my timeline for a banking collapse.

      As to commercial real estate there was this from S&P Market Intelligence a fortnight or so ago.

      “Some U.S. bankers think animal spirits are running amok in commercial real estate.

      During the first week of third-quarter earnings season, several bankers said they were pulling back from CRE due to the competitive landscape or “late-cycle” concerns, which suggests the sector could be headed for a downturn. Home BancShares Inc. Chairman Johnny Allison did not hold back during his bank’s Oct. 17 earnings call, directly comparing recent exuberance to the 2008 financial crisis

      “These are really dangerous times for banks,” he said, calling out competitors for pursuing a “race to the dumbest” deal. He said lenders are offering nonrecourse loans with rates less than 4% and leverage of 80%, adding that the market has become particularly frothy since the Federal Reserve cut rates. Over the time the Fed dropped its benchmark by 50 basis points, lenders have lowered their rates by 150 basis points to 200 basis points, Allison said.

      “It was kind of crazy, it was almost like they turned out the wild animals,” Allison said, according to a transcript.”

      Sound familiar?

  3. “President Christine Lagarde the former Finance Minister of France the Vice-President Luis de Guindos is the former Economy Minister of Spain. So much for the much vaunted independence!”

    As you have strayed into politics, were you not aware that the EU is, in large part, a Superannuation Scheme for Failed Politicians? It also allows these same failures to divert EU (our) money into the pockets of their chums. I am old enough to remember the occasion when the entire Council of Ministers (apart from Neil Kinnock) had to resign because of corruption.

  4. Hi Shaun

    One of the problems with talking about the ECB is that it isn’t a “proper” central bank; it’s a halfway house political construct.

    The two schools of thought are about whether the national central banks should maintain distance from the ECB or whether a more integrationist policy is followed. Lagarde is an integrationist who I’m sure sees the more active role for the ECB in the context of the political integration of the EU.

    The integrationist view takes the stance that the ECB should be willing to buy the bonds of the member states and bundle them. This however brings the ECB much closer to fiscal policy in the member states and the debt monetisation which is implied and which is of course banned by the Maastricht Treaty.

    It seems to me that this more integrationist view holds up two main issues. Firstly it could introduce debt monetistion by the back door and the long term potential risk of hyperinflation. Secondly it might open up the door to a type of fiscal sharing rather than outright union. If the Lagarde view of bundling is followed then presumably the value of a bundle will reflect the strengths of the components and any losses will be shared jointly. Whether this would be enogh to scare the horses of the German Constitutional Court remains to be seen.

    In summary Lagarde may well take the ECB down a more active and integrationist route and, in this respect, she may be a better choice than you think because these moves and problems may have political implications rather than technical ones.

    • Hi Bob J

      I spotted a stalking horse for the integrationist route earlier.

      Ah only 20-25% which is of course rather a lot! We also know what will happen next.

      I see the gain for the weaker economies but unless DB is set to fail why would Germany sign up?

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