Mario Draghi and the European Central Bank (ECB) reported to the markets on Thursday 12th September. The headline interest rate will be set 10 basis points lower — representing a shift from -0.4% to -0.5%. The statement advised that rates are going to stay at present or lower levels until inflation picks up. That wait for inflation to pick up might require a degree of patience.
Carsten Brzeski, analyst at ING, wrote in a note that with rates at negative levels, policy may be drawn towards fiscal measures rather than monetary ones. Brzeski describes fiscal policy as ‘the elephant in the room’. (Source: ING)
The very valid and still outstanding question is ‘how much would a further cut in ECB rates actually help?’ With base level interest rates already below zero, the marginal inflationary benefit from further cuts could easily be outweighed by the damage to the banking sector that comes from the same move. The ECB is dealing with a double-edged sword. Lower rates make it harder for banks to turn a profit and an ailing banking sector restricts the wider economy.
Step one is to leave interest rates at current levels or lower, until inflation picks up. Step two is the reintroduction of quantitative easing (QE).
There had been some debate about whether there would be a kickstart to QE. Confirmation that this would be the case came on Thursday — although there had been less of a consensus that it would happen, it didn’t immediately move the markets. This was mainly because the amount of stimulus was stated to be 20bn euros per month. This is comfortably in line with expectations. Doves had thought the monthly injections might be as high as 30bn euros per month, whereas hawks had suggested QE may not come in to play at all. As it is, the QE policy comes into effect on 1st November and interestingly, there is no end date attached to the policy.
Holding the middle ground in terms of QE levels and pitching a 10 basis point rate cut are indeed moves that relax monetary policy. But neither of these two moves could be described as an ‘upside dovish surprise’. The immediate whipsawing in prices of the DAX Index was limited to a range of 1.2% and 10 minutes after the announcement the DAX was trading approximately 0.5% higher.
DAX Index (XETR–DAX) — Price chart — One-day
As is the way with such events, the headline figures are often supported by statement notes or interview answers, which shed as much light as the hard data. Two items that have already been picked up by the markets are the calendar for ‘guidance’ announcements and the ‘convergence’ towards inflation targets.
One new change to disseminate is that forward guidance on rates will no longer be calendar-based but open-ended and state-dependent. This builds in more flexibility and could also be a nudge by Draghi towards member states, encouraging them to make more of the fiscal policy tools available to them.
There will also be much analysis of the exact words used in relation to the meeting of inflation targets. Of the ECB, Elliot Smith of CNBC notes:
“It now expects interest rates to remain at their present or lower levels until it has seen inflation outlook ‘robustly converge to a level sufficiently close to but below 2% within its projection horizon, and such convergence has been persistent.’”
The euro weakened on the news of the further relaxing of monetary policy. Although the rate cut had been largely priced in, the extent of the measures and the introduction of open-ended QE signifies the ill-health of the eurozone member countries. Even against the depressed pound sterling, it fell away 0.6% to 0.889.
EURGBP — One-day price chart
Next week it’s the turn of the US, when the Federal Reserve’s Federal Open Market Committee will meet to discuss its take on economic health and monetary policy. The ECB announcement of Thursday will do little to change expectations that the US is due a 25 basis point cut. In fact, should a move of at least that size not happen, then it will be considered one of the biggest surprises of the year.
As with the ECB decision on Thursday, it will likely be the ‘forward guidance’ that generates most debate among analysts and traders. Some ‘trailers’ for next week’s events are already running. Steven Mnuchin, US Secretary of the Treasury, was speaking with CNBC on Thursday, immediately following the news that the ECB had again lowered rates. Asked if there might be a change to the long-established ‘strong dollar’ policy, Mnuchin said:
“We’ve been focused on a stable dollar. That is something over the longer term.” (Source: MarketWatch)
The tone of his response was that the ‘stability’ rather than the actual level of the dollar might be of paramount importance to him.
A tweet sent by President Trump within an hour of the ECB announcement gives a clue as to what he might want to happen:
“European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports…. And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”