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Thursday, September 05, 2013

ECB preview - is the ECB already seeing the limits of its new communication policy?

The ECB holds its monthly meeting today in what may be seen as the most positive eurozone economic environment for some time.

Having previously been earmarked as a meeting which could see a further rate cut (a prediction which has evaporated due to more positive economic data) this meeting is now likely to be dominated by ECB President Mario Draghi’s attempts to restate his new communication policy.

July saw the launch of this policy, focused on ‘forward guidance’ (forecasting future interest rates) and the potential publishing of minutes of ECB meetings, in an attempt to add a new tool to the ECB’s monetary policy arsenal. However, in recent weeks there have been indications that the ECB may already be seeing the limits of such an approach.

Forward guidance struggles

  • As the chart above shows (via Commerzbank) indicators suggest that future overnight short term interest rates are expected to increase, while the borrowing costs for short term bunds and other core eurozone countries have also been creeping up. Expectations of an ECB interest rate increase have also been brought forward significantly, whilst the euro has also been strengthening recently.
  • Much of this is off the back of recent good data from the eurozone, of course a positive, but given that the data is far from comprehensive and problems still abound for the eurozone its clear the ECB is not yet ready to change course.
  • Of course, given that it is early days for this policy and that the rate moves have been small it is impossible to draw a definitive judgement just yet, but there are signs of limits to the policy.
ECB Total Balance sheet (€m)
  • The ECB is also seeing its monetary policy being effectively tightened as the Long Term Refinancing Operation (LTRO) loans are repaid, with its balance sheet shrinking (chart above) to its smallest size since the start of 2012, and no signs of banks increasing lending to the real economy to compensate. Again, a positive indicator but not quite what the ECB might have wanted with the introduction of a new tool indicating loose monetary policy for some time.
  • External conditions have also not been helping. The Bank of England is facing a similar issue, for similar reasons, while the US Fed has announced the prospect of slowing down its Quantitative Easing programme – the much maligned ‘tapering’. This has unsettled markets and threatens to reduce liquidity globally – so far much of the pain has been felt in emerging markets, but it could yet spill over into peripheral Europe, hitting demand for government and corporate debt and pushing up borrowing costs.
Backing away from minutes

The other part of this new communication strategy was a move towards publishing minutes of ECB Governing Council meetings, with many ECB members issuing support. However, there are indications that this may also come up against problems (as might have been expected).

The concern has always been that divergent views within the ECB (read, from the Bundesbank) would make ECB minutes more trouble than they’re worth. Over the past few weeks we have seen the Bundesbank use its monthly bulletin to warn that rates could still increase and attempt temper the commitment under ‘forward guidance’, while its President, Jens Weidmann, has also warned of the potential "pressure" on decision makers if minutes were published. Additionally, comments from Austrian Central Bank Governor Ewald Nowotny suggested that the ECB might be backing away from the plans (such interventions are rarely made without some approval from the ECB hierarchy as we saw when minutes were proposed):
“My personal view is that of the founding fathers of the ECB…They were very cautious to secure the independence of the ECB by not giving minutes on the individual votes of the members of the Governing Council.”
All these factors then, have worked to expose some of the frailties of the ECB’s guidance policy, not least that it remains much more vague and unfocused than those employed at the US Fed and the BoE. The ECB (with some good reason) is hesitant to get into specifics over the timeline and conditions for keeping rates low – this will clearly hamper the usefulness of this policy tool (and brings us back to questions about how many tools the ECB really has at its disposal).

In fact, there is already talk of using another LTRO to bolster this policy and help stop any upward movement in rates, although given the limited impact of the initial LTROs (beyond avoiding a bank funding crisis) this may not help much.

All that said, the ECB is unlikely to drop its new communication approach in the near future, leaving Draghi the unenviable task of continuously restating the ECB’s commitment to this policy – expect this to begin in earnest at today's meeting.

3 comments:

Anonymous said...

Keeping quiet and not telling anyone what they are really planning is probably a good move for them, the value of the euro would plunge if they released this information.

Rik said...

Having a single mandate makes the new communication strategy considerably more difficult. Especially in the current climate where the ECB have become 'political' for a large part.
Simply not possible to use unemployment or growth as the major deciding factor when your mandate only gives price stability at least in your speeches or notes.
While pricestability itself doesnot seem to be the largest of the problems the EZ is facing.

In more general terms the EU will have to improve its communication in general. Present way its institutions sell theirselves is appaling. A lot of the communication could have been done by the famous PR agency LePen, Wilders and Farage.
One of the main issues being openness.
All gives the impression of backroom decided undemocratic not for the country you live in stuff.
From that angle making notes public like most CBs is probably a good thing.
They could make a distinction between publised and the internal version. With eg not mentioning who was pro and who was not. However this is not really that big an issue. After a relatively small period from other signals it is clear where members stand. Easy to make a good calculated guess on the important points (rest is pretty irrelevant anyway)

Brushing pricestability somewhat to the background looks to be a dangerous thing. Probably one of the main reasons rates went up. King did that much better (more stealthy).
Problem with the BoE being the higher inflation from the King period. Probably it looked like higher inflation (bad inflation not caused by growth and not compensated in higher yields)
was a more structural issue that way (and was clearly not priced in). With the market reacting on that.

Another reason why the new policy isnot properly working is imho that the first attempt (by the FED) was simply awfully managed.
If you combine it with letting air out of a bubble that you yourself have created things get mixed up. As well as with the taper which was a first by itself anyway.

FED should never have the bubble develop that far in the first place. Plus should have uncoupled forward guidance and letting the air out.
And as said earlier doubtful if it is very useful in a one mandate enviroment where the main trouble is not so much related to that one mandate (like with the ECB at the moment).

ECB should be careful with things. The market sees it clearly now as an almighty institution it isnot. When the BuBa or Germany pull the plug it is a goner as simple as that. Even when it becomes a real possibility. It should be much more careful with its credibility. When that start to erode it and the EZ/Euro are a goner.

Rik said...

Hard to see imho if the EZ has hit rock bottom and the only way would be up.

Imho there are more indications that is not the case (than it did).
Combined with the fact that a lot of the positive noise seems to have a high degree of window dressing.

Next to the issue that we are dealing basically still with seperate countries and there is a huge divergence issue.

I got the idea that unemployment might be the real indicator.
On of the main reasons why I am sceptic as it doesnot look great.

I would say something like at least 2 out of France, Spain and Italy have decreasing unemployment numbers.
There will be a delaying factor mainly because of labor protection. So if this one turns you can be pretty sure things have moved in the right direction.

SA (seasonally adjusted) of course and properly. Not hiring holiday workers for the beach season stuff. One of the reasons I add properly, is that Spain is simply 'forgetting' to mention that point.

You likely will see more temp and parttime stuff. Thing to watch that it is not exchanging 1 full time job for 2 parttime while in that process reducing unemployment rates. Like the US.

Anyway it looks more and more that a lot of windowdressing is done. Which use is doubtful imho.
Gives short term positive news. But with long term crisis like here it can and likley will come back to hunt you. Too long crisis simply mean that skeletons will start dropping out of the closet.