The ECB – What Have They Just Done?

The European Central Bank is, as the name suggests, the central bank responsible for monetary policy across the Eurozone group of countries. The institution has been nursing the economy along since the credit crisis of a decade ago, although continues to battle with some fundamental issues, such as the fact that although the Eurozone shares a common monetary policy, fiscal policy – so taxation and public spending – remains delegated to the individual member states, albeit protected by a so-called fiscal compact. This sets some broad rules in terms of preventing overspending – as the news Italian government found out when trying to get its latest budget approved by technocrats in Brussels.

Since 2008, monetary policy at the ECB has been defined by its accommodative nature. Ultra-low interest rates have been used to discourage saving and drive investment. On top of this, a bond-buying scheme worth some EUR2.5 trillion was deployed between 2009 and 2018 in a bid to boost credit and in turn economic demand. That was finally concluded at the end of last year, with its results being seen as questionable. So-called quantitative easing – or QE for short – when central banks buy up corporate debt had been largely untested previously. By all accounts, whilst it may have helped stave off the threat of deflation, overall economic growth has remained subdued.

One problem with maintaining ultra-low rates for so long is that the overall economy is cyclical. Despite the best endeavours of policymakers, the good times are inevitably followed by bad, with such cycles often being seen as lasting between seven and 10 years. So in a classic situation, central banks will tighten monetary policy during the boom, gradually hiking interest rates to prevent the economy from overheating, but also providing some valuable ammunition for when the inevitable slowdown strikes. At this point, interest rates can be cut, discouraging saving and hopefully fuelling underlying economic growth.

In June 2008, the ECB’s main refinancing rate was at 4.25%. Ten months later it had fallen to just 1% and by March 2016 it was at 0%. Now, as the economy beings to slow, the ECB is very short on ammunition. As part of the termination of quantitative easing at the end of last year, ECB chief Mario Draghi announced the intention to start increasing interest rates from later this year, in a bid to have some headroom when the next slowdown struck. As we found out at the ECB’s March monetary policy meeting, such plans have now been comprehensively struck down.

On March 7th, the ECB hit markets with a triple whammy. Growth projections for the year were cut from 1.7% to 1.1%, the prospect of an interest rate hike was pushed back to 2020 and a series of new, Targeted Long Term Refinancing Options (TLTRO’s) were announced. The news was seen as inevitably taking a toll on the Euro, but the extent of any sell-off was going to be dictated by how aggressively the ECB was prepared to act. This combination was sufficient to see EUR/USD make its biggest one-day decline in nine months and hit its lowest level in almost two years.

The challenge now however is that the ECB has somewhat ‘kitchen sinked’* the situation. They have thrown a lot of ammunition at the problem and if this doesn’t work, fresh stimulus measures are going to once again be untested.

  • The February Eurozone inflation figure will be published on Friday March 15th. Although it will take a while for the effect of these stimulus measures to be seen, if inflation is decelerating too quickly, market consensus may be that the ECB has left it too late. The Euro could come under some significant pressure as a result.
  • The forward-looking ZEW survey for the German economy will be released on March 19th. The data here is collected in the two weeks prior, so some of the survey responses will likely reflect the change of policy stance at the ECB. Failure to see a rebound here could again flag concerns that the ECB has done too little, too late, resulting in fresh downside for the Euro.

Note also however, that with the Euro trading at these multi-year lows, some bargain hunting may prevail. Shock economic announcements have the potential to leave the common currency exposed in the short term, but fairly swift reversions may follow.

 

*- Kitchen sinking is more common in corporate financial circles, where companies forced to issue bad news will tend to throw everything out there in one go. Rather than drip feed the market, the ECB has thrown everything it readily has at its disposal in a bid to see off this problem.

 

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