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Will Draghi go out with a bang ?

September 9, 2019

 

ref :- "Draghi in spotlight over stimulus as investors eye pace of bond purchases" , Market Questions / Global Outlook, The Financial Times

 

Travelling this week but thought we'd better remind you about the European Central Bank's monetary policy decision coming up on Thursday ..... as if you weren't well aware anyway ! It'll be ECB boss Mario Draghi's final policy meeting, and at the last get-together Super Mario made it pretty clear that slowing growth and softer inflation data meant that we should expect to ease measures this time round.

 

Mr Draghi has of course shown himself to be admirably decisive in the past  --  remember him promising to do "whatever it takes" to save the Eurozone from collapse back in 2012 ?  --  and one suspects that deep down in his inner self he'd really like to exceed market expectations and give the flagging Eurozone economy a real shot in the arm. This time round however things are not that simple.

 

The two avenues open to the ECB if they want to add fresh stimulus is to cut rates, and to re-start the bond purchasing QE programme. The problem with cutting rates, and particularly with cutting rates aggressively enough to surprise the markets, is that the ECB's current deposit rate is already at MINUS - 0.4%. That's not to say that they won't cut  --  they definitely will, but how far can they go from here ? There are questions, very legitimate ones in our humble opinion, about how effective pushing rates further and further into negative territory really is as a method of stimulus. There are even some strong views knocking around that it may even be counter-productive. Negative rates are obviously good news for borrowers, which should encourage investment and consumer spending, but they're not much cop for lenders who at some stage are likely to have absorbed enough pain and will prefer to keep their cash under the proverbial mattress.  It's much the same thing with quantitative easing, with much of Eurozone 10yr government debt offering negative yield and that of Germany and the Netherlands yielding less than the deposit rate of -0.4%.

 

Talking of Germany and the Netherlands ..... it couldn't matter less what people like us think, but Mr Draghi will have to take into consideration the views of those on the ECB board who don't share his doveish stance..... and there are a few. Jens Wiedmann and Klaas Knot, presidents of the Bundesbank and the Dutch central bank respectively, are the most high profile members of the fiscally conservative faction at the ECB, and have long argued against the highly accommodative path taken by Mr Draghi. Their reasoning is well known and befits representatives of the wealthier Eurozone members : ultra-low and negative rates punish savers , they undermine the banking system, they create asset bubbles etc. etc. etc.

 

Both men were quieter than normal in the period when a number of top jobs were being handed out, including that of the next boss of the ECB. If they dialled back their objection to current policy in an (unsuccessful) attempt to curry favour with the nations less inclined to embrace fiscal prudence, they have no such constraints now and will have been arguing against further easing. They won't have been successful but may ... repeat may .... have acted as a brake against the more extravagant stimulus measures.

 

So what to expect ?

 

The more dovish are looking for a 0.1% cut in the deposit rate to MINUS -0.5, with a further cut of the same size in the pipeline for Christine Lagarde's first policy meeting as ECB chief in December. They also expect €40bn per month of new bond purchases. Others believe that bond-buying will be limited to €25bn per month for six months. On top of acknowledging the views of the more hawkish members, that figure would also have the considerable benefit of avoiding the need to raise the limit on how many of each country's bonds the ECB can own,  a step that could be something of a political minefield.

 

And as far as a further cut in December goes, even hawks would concede that having nailed her doveish colours to the mast on accession it's hard see Mme Lagarde not following in the direction signposted by Mr Draghi.... unless there's some sudden and marked change in the data, of course.

 

Given that a cut of 0.1% is all but guaranteed on Thursday, only one other thing is as certain : President Trump is going to vilify Mr Draghi as a currency manipulator. If Mme Lagarde does the same in December, she'll get the same treatment ... and on both occasions Chairman of the US Fed Jay Powell will be getting it in the neck for NOT doing the same thing.

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