“Whatever it takes” Five years later

Five years ago, Mario Draghi made remarks in London that have changed the world.
When he spoke in London on July the 26th 2012, the Euro area was in its deepest recession since WWII* and two important countries, Italy and Spain, were following a non sustainable trajectory that can be described as a deep recession with high real interest rates.

These problems came from the European decision to follow austerity policies. These latter dramatically reduced domestic demand but without having a strong impact on public finance. So the main question for Italy and Spain was the date of their exit from the Euro area; not if but when.
An exit from these two countries would have led to a collapse of the Eurozone. This would have destabilised the world economy.

Five years ago, in London, Mario Draghi did three things

First he said that the Euro Area was a political construction. It was the result of countries' will to live together. It has worked. The area has been in peace since WWII. This is the most important point for Europe. The euro currency is just a technical commitment. An important one but not more than that.

The second point is the following: if the currency is just a technical mean to improve the way the Euro area political framework works then it has to continue. The collapse of the Eurozone (after an exit from Italy or Spain or another country) would have been a source of political instability in Europe and probably the end of most European institutions.
The role of the ECB was to save the Eurozone by avoiding a collapse of its currency.
The famous sentence "whatever it takes" (the whole sentence is "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.") explains this new mission.
After this sentence the ECB became the lender of last resort that a monetary construction needs. Until this moment the central bank had never played this role. It's a fracture in the European institutional framework.
In a situation where governments didn't know what to do, the ECB became the leader under the auspice of Mario Draghi.

The third point came few days later at the ECB monetary policy meeting with the creation of the OMT which allows the ECB to buy assets (public debt) mainly in Italy and Spain. This was enough to reduce tensions on these two countries. Later in 2012 and after in 2013 the interest rate spreads with Germany decreased dramatically. This was the end of the main divergence within the Euro area.

The ECB has been a game changer by avoiding the collapse of the European construction. Since then, economic policy leader is the central bank under the impulse of Mario Draghi. Progressively the fiscal policy has converged to a neutral stance. The Eurozone economic policy is now done in Frankfurt more than in Brussels.
The QE strategy was consistent with this new ECB framework. It had to create the necessary impulse that would provoke the recovery. It has worked with all the instruments used in this non orthodox monetary
The European Central Bank has been the channel for a smooth adjustment in the most important financial crisis since WWII.
Its job is now almost over as the growth recovery is now strong. It just have to keep its accommodative monetary policy in order to ease the needed political adjustment. The next step of the Eurozone institutional construction is political. It's time for government to take the relay.
We will forget a lot of ECB presidents, past and future, but Mario Draghi will remain as the one who save the European construction.

* The Euro Area has started in January 1999, but if we look at the economic situation of constituant countries since WWII none of them has had such a recession.

The ECB hasn’t changed its mind on its monetary policy

The ECB remains committed for an extended period to a very accommodative monetary policy stance.
There is no strategic change in the ECB economic diagnosis on the Euro Area. The recovery is getting strength and risks are now balanced. But the inflation rate is still way below the ECB target at below but close to 2%. On this specific point the ECB explains that the low oil price is an explanation but it is not sufficient as the core inflation rate is still close to 1%. Draghi said the inflation should stay close to the current level (1.3%) in coming months. Therefore no convergence to the target is expected by the European Central Bank in a foreseeable future.
In other words, the recovery is strong for the real economy side but still very limited on the nominal side. As far as the inflation rate remains low, the monetary policy will remain accommodative; the ECB will continue to purchase large amount of assets as long as long term inflation expectations do not converge to the target. It could change its mind also in case of inflation surge in coming months but that's not the ECB perception of its profile.

I do not perceive in the ECB statement a change in tone or in the way the monetary policy will change in the future. Those who thought that there was a new message at the ECB seminar in Sintra were wrong.
The asset purchases program will be discussed next autumn (probably in September) as the current one is supposed to end in next December if long term inflation expectations converge to 2% or if the inflation rate is close to the target. The amount which is currently at Eur 60bn per month will probably be lowered in 2018 as the recovery is strong but we won't have a termination date as long as the inflation rate at 2% is not expected rapidly. We can expect 30 or 40 bn per month after December 2017.
The ECB has not to hurry in changing its monetary policy stance as its impact is asymmetric. Changing it too quickly is taking a negative risk on the recovery – that's not what is wished by the ECB for the Euro area economy. The central bank can wait for a higher inflation rate before changing its mind.
The ECB target must be a stronger and more autonomous growth momentum supported by the domestic private demand. For that, an accommodative monetary policy for an extended period is still the recipe.

Political watershed at the heart of Eurozone growth

The euro area is looking like a haven of stability these days. The election of Emmanuel Macron and his strong relationship with Angela Merkel have driven expectations that the economy will get back to more robust growth and that the political arena will take the steps required to embark on reforms that will maintain stability in the long term.

This watershed is remarkable as barely six months ago, the euro area looked like it was on its last legs. The expected surge in populism during the various different elections was set to hamper European integration and set off a downward spiral of lessening cooperative and greater antagonism.

Yet as July gets off to a start, we can observe that this is far from the reality and that European electors did not follow the path chosen by the US and the UK. Continue reading

United Kingdom – Weak domestic demand and higher rates from the Bank of England – A recipe for a recession?

Negotiations on Brexit may lead to a negative and persistent shock in the United Kingdom as it will deeply change rules for the external trade. Therefore there is a need to carefully look at the domestic demand momentum in order to eventually counterbalance this negative and persistent shock.
At the same time, the Bank of England has mentioned (Carney in Sintra or Saunders here) that the monetary policy could be normalized. In other words, the BoE is wondering if there is still a need for stimulus. Here too it is interesting to carefully look at the domestic demand to see if the need for stimulus is superfluous or not. Continue reading

The Chinese bond market opens

Co-authored with Zouhoure Bousbih

The Chinese bond market is becoming more international and opening up to foreign investors. Coinciding with the 20th anniversary of the handover of Hong Kong to China, the Chinese authorities are displaying their aim of shaping world affairs, acting directly on the largest and most important financial market worldwide.
The Chinese bond market is the third largest worldwide after the US and Japan, with assets of $9,000 billion (source FT) if we combine sovereign bonds, agencies and corporates.
Foreign investors only account for 1.5% of this market, which is ridiculously small for an economy the size of China’s. The magnitude of the Chinese economy in the world and the proportionate weighting of its bond market are not yet comparable. But this is set to change, and this shift in balance will mark a lasting transformation compared to the current situation.   Continue reading

It’s all up in the air with central banks

Have the central banks become sources of confusion for investors? We may well think so after comments by the president of the European Central Bank Mario Draghi, and the governor of the Bank of England Mark Carney. At the ECB conference held during the week of June 26, both made comments suggesting a swift change in the two institutions’ policies.

Mario Draghi referred to above trend growth in the euro area to imply that the ECB should factor this in when deciding on its strategy. He stated that “deflationary forces have been replaced by reflationary ones”, and listeners instantly took this as a sign of the end to monetary accommodation with the beginnings of tapering at a specified date. This prompted a surge in the euro against the dollar and a swift rise in long rates. The ECB indicated that this reaction was too forceful and that investors had over-interpreted the president’s comments.

Meanwhile at the Bank of England, Mark Carney hinted at an interest rate rise by the central bank, having displayed quite a different stance just a few days before. At the latest Monetary Policy Committee meeting, the Canadian governor of the Bank of England had left the policy stance unchanged, leading to a rise for sterling and the 10-year interest rate. Continue reading

Euro Area – Robust Momentum in the Manufacturing Sector (June 2017)

Strong profiles for Markit indices for the manufacturing sector in the Euro Area. This reinforces growth prospects for the region. All countries are growing even Greece for which the index is above 50 for the first time in a year (but only one month June2016). France is now marginally above Spain and Germany is very robust. The consistency of all these indices will improve trade within the Euro Area feeding economic expansion

New orders momentum is getting stronger at the end of the second quarter. This should lead to a strong acceleration in the manufacturing production index in the months to come. This will feed trade and growth.
At a disaggregated level, Germany has the strongest dynamics for orders. Italy and France are trending upward and Spain is in a robust trend, but not an accelerating one.
Pressures on prices are weaker in June. This is linked to lower oil prices. This will reduce tensions on the production price index. The ECB will not see higher inflation momentum and has no reason to change its mind.