ref: - "ECB chief Draghi uses swansong to call for unity”, International Section, The Financial Times
ref: - "Negative rates and the Swedish experience”, Letters, The Financial Times
First up, just a quick reminder that the US Federal Reserve's Open Market Committee begin their two-day meeting today and will announce their monetary policy decision tomorrow. If there doesn't seem to have been too much hullabaloo ahead of this event, it's probably because their decision is pretty much a foregone conclusion and has been for some time. There may be a few dissenters on the board, but as much as anything the threat of global headwinds to the US economy will prompt the Fed to take more pre-emptive action and cut the band for Fed Funds by a further 25 basis points to 1.50 - 1.75%.
US rates are already extremely low by historical standards but at least they are still in positive territory, which means that the Fed still has some room to manoeuvre… just not very much. But that's more than can be said for the European Central Bank, who nevertheless last month reduced their deposit rate from -0.4% to -0.5% and resumed their Quantitative Easing program of bond purchases in the face of rapidly slowing data and inflation predictions. In effect, it was the last hurrah of outgoing ECB president Mario Draghi before handing over to Christine Lagarde.
The Fed may have some dissenting voices, but the divisions within the Eurozone are much more marked and potentially more damaging. There has long been a split between fiscally prudent nations (largely from the north of the Eurozone) and those they see as their more irresponsible, high-spending partners (largely in the south). The former has always argued that negative rates punish savers, undermine banks, create asset bubbles etc, and view QE as a mechanism that forces the wealthier nations in the Eurozone to fund the less well-off. The bosses of the German, Dutch, Austrian and even French central banks publicly disagreed with last month's moves, and a line of former ECB personnel queued up to express the same opinion.
But Mr. Draghi has never been afraid of taking the measures he deemed necessary to achieve his goals even if they did not please some very heavyweight colleagues. Since those goals included staving off some extremely real threats to the very existence of the Eurozone, and he was successful, Mr Draghi's view has continued to prevail over those of the unhappy dissenters.
But being nobody's idea of a fool, Mr. Draghi is plainly as aware as everyone else that monetary policy cannot do all the heavy lifting by itself… especially not from these levels. Yesterday, as he hands the baton over to Mme Lagarde, Mr. Draghi emphasised the need for the maintenance of unity, and as part of the required fiscal support required also called for a sizeable common budget "large enough to stabilise the monetary union".
Hmm… it is one of Mr. Draghi greatest achievement's that he has managed to keep all parties in line even when they plainly were not of the same opinion, but the common eurozone budget is a huge bone of contention in itself. The brainchild of France's President Macron, it has had to be watered down to keep those nations who have given it a decidedly lukewarm reception broadly onside. They are the usual suspects who fear it's another avenue through which money will be sucked from the wealthier nations to support the spendthrifts. The Dutch, in particular, have repeatedly threatened not to participate.
We feel for Christine Lagarde… most will judge Mario Draghi as having done a fine job in difficult circumstances, but his term happens to be finishing at a time when economic portents are far from rosy. The new boss' monetary policy options are pretty much exhausted (whatever the ECB says to the contrary), and getting Eurozone governments to agree a coordinated fiscal approach could be the Devil’s own job. Good luck to her…
Talking of negative rates and their long-term effectiveness (or lack of it), Mme Lagarde might want to check out the letter from Peter Malmqvist, the Chief Equity Analyst of the Association of Swedish Shareholders, published in today's FT. After a period of aggressively lowering rates, Sweden's central bank (the Riksbank) pushed rates into negative territory in early 2015… where they remain. House prices exploded that year by 15%, by 9% in 2016 and by August 2017 by another 7%.
A surge in construction followed: 31% in 2015 and another 27% in 2016. The same thing happened to car sales, and the adventure into negative rate policy seemed vindicated when in July 2018 inflation finally broke up through the key 2% level… Hurrah!
And now? Rates are still negative as the Riksbank stretched the experiment to maintain the hard-won victory in reaching 2% inflation., but after August 2017 house prices dropped 10% in four months, construction dropped by 30% and car sales by 20%. Oh… and inflation dropped from 2% back to 1.5% even with continuing negative rates.
Mr. Malmqvist's conclusion is that interest rate stimulus can only work so long. It's a short-term fix that creates bubbles but not longer-term solutions. It seems completely fair to us… but as we've been discussing, getting all fiscal is not likely to easy either…