You know, there are still some old greybeards about struggling to come to terms with negative interest rates as a concept, never mind as central bank policy. It's a mad world all right, and it's hard not to have a little sympathy. In the grand scheme of things, it's not that long ago that a debate about whether the ECB could start raising its deposit rate of -0.4% before finishing its €60bn per month bond buying programme (it was €80bn, and is due to finish at the end of 2017) would have seemed like a conversation from a parallel universe..... an inverted one, naturally.
Extraordinary events like the financial crisis, and the Eurozone crisis that followed a few years later, sometimes call for extraordinary remedies. But one of the major problems with implementing unprecedented policy measures, even if they are judged to have done the job, is that nobody can be quite certain how best to "normalize" things when the time comes.
Sequencing, and the principle of lifting rates before QE is complete, is contrary to the thinking of Peter Praet, the ECB's chief economist. But since at least two high-profile board members have suggested that there are circumstances that would justify doing exactly that, it's not surprising that there's a little confusion about the ECB's plans -- not least among board members themselves, it seems. So it's handy that Bloomberg have put together a quick Q & A piece to clarify the situation, though whether the ECB will be able to present a clear and unambiguous front on the issue that doesn't mask hidden caveats must be open to doubt. Anyway, .......
1. What's the current plan for exiting stimulus ?
Er ..... there isn't one, at least not officially. What happens after the end of 2017 when the current QE programme expires has not been formally discussed. Will asset purchases just be terminated, or will they be gradually reduced ? If so, how ? What we do know on the other hand is that the ECB is on record as saying that interest rates are expected to remain at or below current levels for an extended period, well past the end of QE.
2. How did the idea of Sequencing arise ?
The subject was raised briefly at the ECB's Governing Council meeting in March, news that boosted both the Euro and bond yields. They were boosted even higher by comments from the boss of the Austrian central bank, Ewald Novotny, effectively suggesting that it was possible to raise rates before the end of QE.
3. That must have been an unwelcome market response ?
Definitely ..... Peter Praet immediately emphasised that the ECB's "forward guidance" -- QE ends first -- was very clear and had "a strong logical basis". It's a message that he has reiterated since, and ECB boss Mario Draghi has also waded in by repeating the official view that inflation is too subdued to contemplate upward moves in rates.
4. So what's the "strong logic" behind ending QE first ?
Most simply, the official line is that the yield curve should be allowed to steepen (longer rates at more of a premium over short-term rates), which would be the natural consequence of ending asset purchases, BEFORE hikes in rates lift the whole curve in its entirety.
5. Seems reasonable .... anything else ?
QE has never been universally popular, particularly in Germany where some have even argued that it breached EU rules in that effectively finances governments. Those averse to QE are more likely to put their energies into fighting to end it rather than pushing for rate rises while QE carries on.
6. What are the arguments for changing the sequencing ?
Primarily, it's about banks and the squeeze that negative interest rates put on their margins. Generally, banks are unable to pass on a cost for depositing money to their customers -- at least, not if they want to be sure in keeping those customers. It's not the ECB's role to aid bank's profits, but anything that affects their ability to offer credit would be a concern. It's a scenario that has been exercising the mind of Benoit Coure, the highly influential ECB board member.
Also, there's the argument that changing the sequencing might give the ECB the flexibility to use all its policy tools for longer. It could slowly tighten policy with a combination of small rate rises and reductions in the pace of bond buying, for example.
Mr Praet is likely to call for unanimity among the Governing Council at its next meeting on June 8th. Officially, he may get it but the concerns expressed by Mr Coure and others are unlikely to disappear. This is not an issue that's likely to explode .... it's just on simmer for now. But the ECB's tactics when it comes to withdrawing stimulus will have impacts on currency and bond markets in particular, and sooner or later investors will need to know more.