Will ECB walk or just talk as rate circus comes to Europe?
BRUSSELS (Reuters) – The global march towards lower interest rates reaches Europe this week with the European Central Bank expected at least to signal easier monetary policy, while Turkey’s new banking chief is seen taking an ax to the country’s rates.
Slowing global growth, increased protectionism and in some cases weak domestic data have persuaded major central banks to loosen monetary policy, with a rate cut more or less inked in for the U.S. Federal Reserve at the end of the month.
The ECB, whose Governing Council meets on Wednesday and Thursday, said last month that euro zone interest rates would remain at present levels at least through the first half of 2020 – an extension from previous period of until the end of 2019.
Two-thirds of economists polled by Reuters expect the ECB next week simply to change its guidance, such as for rates to be at “present or lower levels” ahead, with a cut of the deposit rate to an all-time low of -0.50% at its September meeting.
“I think for now, they’ll only get to point where they consider a rate cut is on the table and then do it later. The ECB has a long history of moving very slowly,” said Capital Economics’ senior Europe economist Jack Allen-Reynolds.
But some economists believe the ECB will have to do more.
Carsten Brzeski, chief economist for Germany at ING, says he thinks of the chances of just words as 51%, versus 49% for action.
“Draghi has surprised us more often in terms of being ahead of the curve, of over-delivering, but it’s very hard to say. I think there will be a tough discussion,” he said.
If the Fed starts cutting rates and the ECB does not send out an extremely dovish message, the euro could strengthen, although at Friday’s level of $1.12 it is hardly near the pain barrier for EU exporters.
Commerzbank is one bank that predicts the ECB will act, cutting by 20 basis points
“Maybe they want to prevent an appreciation (of the euro) and, like the U.S., they want to prolong the upswing. The data though is not as bad as you might think,” said economist Bernd Weidensteiner.
Unemployment in the euro zone is, at 7.5%, at its lowest level since July 2008, while industrial production and exports improved in May, albeit after declines in April.
In the United States, the case for a rate cut is ostensibly even thinner, with strong labor markets despite U.S.-China trade tensions and factory activity strong – at a year high in the mid-Atlantic region.
Yet markets were by Thursday expecting a half percentage point cut in U.S. rates at the end of July, double the reduction they expected just a day earlier. The action has been sold as insurance against any negative development. U.S. economic growth is expected to have cooled in the second quarter, set to be confirmed in a first GDP estimate on Friday.
TURKISH AX, NEW BRITISH PM
In Turkey, the case for action is more clear-cut given a recession-hit economy. Economists polled by Reuters expect the central bank under new governor Murat Uysal to reduce the current 24% interest rate by an average 250 basis points.
It will follow Indonesian and South Korean rate cuts on Thursday and the Reserve Bank of Australia, which reduced interest rates in both June and July.
The trend leaves only the Bank of Canada, buoyed by higher oil exports and consumer spending, and the Bank of England as outliers, though the latter could change.
Arch-Brexiteer Boris Johnson is expected to be named as Britain’s next Prime Minister on Tuesday, raising the chances of a ‘no deal’ Brexit and potentially lowering growth forecasts.
Only 27 of 76 economists polled now expect an increase to British interest rates before the end of next year, compared to 36 of 69 last month. On the flip side, nine of 76 were expecting a cut by end-2020 compared to five of 69 in June.
“We don’t necessarily share the view that the UK economy will see a substantial pick-up in growth even in a smooth Brexit,” Royal Bank of Canada, a primary dealer of British government bonds, said.
Reporting by Philip Blenkinsop; Editing by Toby Chopra
ZURICH – Finland’s central bank governor, Olli Rehn, has reiterated his call for the European Central Bank to conduct a long-overdue review of its policy framework. The upcoming change of leadership at the institution – with Christine Lagarde, the International Monetary Fund’s managing director since 2011, likely to succeed Mario Draghi as president – offers an important opportunity to heed that call.
When the ECB was established 20 years ago, central banks were generally not too clear about the details of their policy frameworks. At that time, some ambiguity may have been helpful, because of the flexibility it offered when the ECB started operating. Furthermore, it allowed central bankers with different experiences and perspectives to agree on a framework, even though they may not have agreed on its precise details.
But the world has changed considerably since then, and the public is now demanding far more clarity. How can the ECB offer that, 16 years after the last review of its monetary-policy framework?
Since that review, conducted in 2003, the global financial crisis, and the ensuing European debt crisis, prompted the ECB to adopt a plethora of new policy instruments. These crisis measures – which have been deeply unpopular, particularly in Germany – can be justified only to the extent that they have been effective, and this must be evaluated. Moreover, as Rehn, who sits on the ECB’s governing council, has noted, long-run structural trends – such as population aging, lower long-term interest rates, and climate change – must be considered.
The effectiveness of ECB policy requires the members of the governing council to be singing from the same song sheet. They need a shared understanding of Europe’s long-term goals and the strengths and weaknesses of various policy instruments. And, in order to strengthen accountability and support smart decision-making, they need to be able to spell out the details of their monetary-policy strategies in ways that the public can understand.
As it stands, such clarity is at times hard to find, even when it comes to some of the most fundamental elements of the ECB’s policy strategy. Price stability – the ECB’s primary objective – is currently expressed as “inflation below, but close to, 2%.” Does 1% inflation meet that condition, or is it too low, demanding more monetary-policy accommodation? Different members of the ECB’s governing council may well have different answers to this question, and thus support different policies.
The same goes for the questions of whether the ECB’s inflation target is symmetric – with the authorities intervening as vigorously when inflation is too low as they do when inflation is too high – and whether inflation should be measured over time or at a given moment. If, over some period, the inflation rate ranges from 0% to 4%, but averages to “below, but close to, 2%,” has the objective been achieved?
The answer has major policy implications. If inflation is measured over time, the ECB could accept, or perhaps even aim for, a somewhat higher inflation rate in the medium term, to compensate for the excessively low inflation of recent years. If the public came to believe that a period of above-target inflation was likely, the expected real interest rate would fall, giving a jolt to the economy.
Of course, Draghi has established in speeches and press conferences that, in his view, the inflation target is symmetric; 1% inflation is too low; and the inflation rate should be measured over the “medium term.” But it is not clear whether this view is broadly shared within the ECB’s governing council.
Inflation targeting is hardly the only area where ambiguity is hampering effective policymaking and leaving market participants wondering what to expect. The ECB’s outright monetary transactions (OMT) scheme – whereby the ECB promises to purchase bonds issued by eurozone member states on secondary sovereign-bond markets – is also generating significant uncertainty.
OMT, Draghi’s chosen tool for fulfilling his 2012 vow to do “whatever it takes to preserve the euro,” was controversial from the moment it was announced, with Bundesbank President Jens Weidmann – one of Lagarde’s main rivals for the ECB presidency – arguing fiercely against it in public. But that was seven years ago, and OMT has never actually been used. Is the governing council still committed to it? Or have the events – and council membership changes – of the last few years rendered that commitment obsolete?
With public debt in Greece and Italy still far too high, the eurozone still at risk of slipping into a recession that would significantly worsen both countries’ fiscal positions, and Italian politics as volatile as ever, it would pay to know. A review of the kind Rehn demands would provide the needed answers – and put the ECB on much sounder footing for a new era of leadership.
STEFAN GERLACH