Today the European Central Bank starts its latest policy meeting and tomorrow lunchtime we will be told the outcome. To my mind there are three certainties. The first is that ECB President Mario Draghi will call for more economic reforms in his introductory statement. The next is that he will wish everyone a happy holiday season at the end. The third is that he will find a way to point out that in its own terms the ECB has had a Eureka moment.From Eurostat.
Euro area annual inflation rate was 2.0% in June 2018, up from 1.9% in May 2018. A year earlier, the rate was
So the 2% target has been hit and if you take the average of those 2 months you end up pretty near to the 1.97% specified back in the day in the valedictory speech of Mario’s predecessor Jean-Claude Trichet. Next comes this.
Seasonally adjusted GDP rose by 0.4% in the euro area (EA19) (and the EU28 during the first quarter of 2018),
compared with the previous quarter……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro area.
So economic growth and inflation on target as Mario readies us for the last leg of his triple play.
The number of persons employed increased by 0.4% in both the euro area (EA19) and the EU28 in the first
quarter of 2018 compared with the previous quarter…….Compared with the same quarter of the previous year, employment increased by 1.4% in both the euro area and the EU28 in the first quarter of 2018……Eurostat estimates that, in the first quarter of 2018, 237.9 million men and women were employed in the EU28, of which 157.2 million were in the euro area. These are the highest levels ever recorded in both areas.
So as you can see even the perennial bugbear which is the employment situation in the Euro area has improved. This brings me to another certainty these days which is that Mario will run rings around the journalists at the press conference. The only danger to that is overconfidence as he sings along to Flo and her Machine.
The dog days are over
The dog days are done
A nagging problem
The catch to the scenario above is that the punch bowl at this particular party is still pretty full. No longer right up to the brim but there is still a -0.4% deposit rate and this.
would reduce the monthly pace of net asset purchases to €15 billion until the end of December 2018 and then end net asset purchases.
Lest we forget it will be twisting by the pool this summer and beyond.
Third, it intended to maintain its policy of reinvesting the principal payments from maturing securities purchased under the APP for an extended period of time after ending net purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.
One of the biggest beneficiaries does not seem to merit a mention so let me help out. The various Euro area governments will be grateful for the help to fiscal policy via lower borrowing costs especially Mario’s home country because after the election result the bond market there has looked more vulnerable ( 10 year yield 2.65%). Some may think that the new Vice President the ex Spanish Finance Minister was appointed to keep the ECB reminded about this but whatever it does pose questions about the claimed independence. After all it was only at the last press conference that we were told the ECB was struggling to find him a specific role implying he lacked the skills required.
But looking ahead the sovereign bond book will head towards 2.1 trillion Euros and then stay there. So we move on with the nagging worry that people are still drinking from the punch bowl with the band at full volume.
What happens next?
This morning’s monetary data provided some food for thought.
The annual growth rate of the broad monetary aggregate M3 increased to 4.4% in June 2018 from 4.0% in
May, averaging 4.1% in the three months up to June. The components of M3 showed the following
developments. The annual growth rate of the narrower aggregate M1, which comprises currency in
circulation and overnight deposits, stood at 7.4% in June, compared with 7.5% in May
In terms of economic outlook we see that the narrow money supply has stabilised overall at a lower level confirming a weaker economic trajectory. Looking further ahead broad money growth has improved but against that inflation has risen.
The ECB will be pleased to see an improvement in credit provided to businesses but I think that is more of a lagging ( from the period of growth seen last year) than a leading indicator.
A Space Oddity
Strangely perhaps the biggest challenge to the shiny happy people economic view in the Euro area has come from the ECB itself.
The view was also reiterated that the observed slowdown could, to some extent, be seen as a natural development in a maturing expansion after many years of growth above potential. ( ECB July Minutes )
Er haven’t we just seen many years of growth below potential? I know recently things improved but have the credit crunch and the Euro area crisis just been redacted? Also as so often for central bankers we see such thoughts are driven by a rather downbeat outlook.
An increasing number of countries and sectors were starting to run into capacity constraints and labour shortages, implying a “structural” levelling-off of growth,
If true that is a bit grim.
Problems here never really go away and claiming “many years of growth above potential” trims the list of possible excuses quite drastically. There is the ongoing issue of money laundering and corruption in the Baltic nations and of course there is the Italian version.
The ECB appears to have lost patience with Carige, which although worth a mere 500 million euros is one of Italy’s top 10 biggest lenders by assets. It has rejected the Genoa-based bank’s current capital plan, and given it until year end to raise its total capital ratio to 13.1 percent, almost 90 basis points above the current level. ( Reuters )
As you can see the picture on the surface looks good for the ECB and it is true there have been improvements. I expect Mario to defend the ongoing QE and negative interest-rates by pointing out that what he considers to be core inflation is at 1.2% below target. But the old punch bowl argument does pose questions especially as the man who made the original case could not have been aware of how large a modern punch bowl actually is. The vulnerability is to any combination of a further slowing in the economy and pick up in inflation. That will be there for a while as the ECB intends to maintain the size of its stock of QE as well as having no plans to raise interest-rates.
This entailed the expectation that policy rates would remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remained aligned with the Governing Council’s current expectations of a sustained adjustment path. ( ECB July Minutes)
Putting this another way I note that the Taylor Rule would according to the Wall Street Journal have interest-rates at 2.5%. I am no great fan of automatic rules but that is quite a gap and widens if you note the -0.4% deposit rate rather than the 0% rate some like to emphasise. Which returns to the question of why if things are so good we remain enmeshed in zero and indeed negative interest-rates?