ECB surprises markets with interest rate cut and purchases of private assets: Round-up of reactions from around Europe

As we predicted might happen, the ECB surprised markets yesterday with the announcement of an interest rate cut and the purchases of private assets.

Open Europe’s Raoul Ruparel has a full analysis on his Forbes blog, where he concludes:

“In summation, Draghi surprised the markets with some bullish action. That said, I remain unconvinced that these programmes will do much to boost inflation, growth or even credit supply in the Eurozone. Importantly, the ECB is nearing the end of the actions it can take, and it is very aware of this. The onus has now once again been shifted to governments, with the expectations rising for action. For the first time since 2012, pressure is now really increasing for Eurozone governments to reassess the Eurozone’s institutional structures and take action to pool further sovereignty. Draghi may have come bearing gifts for markets but he came with further warning for governments.”

Needless to say, the fallout from the ECB's announcements has been widespread and varied. Below are some of the best reactions from papers across Europe. As one might expect, the German press was less than impressed with the policies unveiled by Draghi:

Die Welt’s Economics Editor Sebastian Jost describes the announcement as “Draghi’s last roll of the dice”, and claims that the ECB has demonstrated “an unusual passion for experimentation”. He also argues that “the ECB has now done pretty much everything which appears to be economically justifiable. Whoever wants a stable monetary union should hope that it does not go any further.”

Süddeutsche Zeitung’s Economics Editor Ulrich Schäfer describes the ABS as a “highly dubious innovation”, claiming that it resembles many of the financial products that contributed to the initial financial crash “when no-one could ultimately identify who had lent whom how much, and therefore who had assumed what risk.” He concludes that it is “ironic” that the ECB wants to give such products “renewed respectability”.

FAZ’s Economics Editor Holger Steltzner criticises Italy and France for delaying structural reforms in order to get more help from the ECB. He also argues, “Does the purchase of securities, which banks are struggling under the burden of, even come under monetary policy?...How can the ECB eventually return to normal? As soon as it increases interest rates, it will threaten itself with losses.”

Again as many would have predicted, the Mediterranean press took a more sympathetic view of Draghi’s decisions.

An editorial in Spanish daily El País argues that “the ECB hasn’t disappointed…[but] it’s equally necessary that the governments with sound public finances – and notably the German government – intensify investment and temporarily back greater flexibility in the necessary requests for public finances adjustment in the eurozone as a whole.”

The deputy editor of Spanish daily El Mundo, John Müller, makes an interesting point, “The enormous debt – both private and public – that has been amassed, is such a huge burden that it is surprising that no-one is addressing the problem seriously...Yesterday, Draghi only asked for help [from eurozone governments] in the form of fiscal measures and reforms, but not [in the form] of debt restructuring. In short, we don’t know if the monetary sorcerer has correctly identified the reason why we have lost the favour of the gods of growth.”

Columnist Jean-Marc Vittori writes in French business daily Les Echos that “the currency won’t be enough to save Europe”, and argues, “[There’s] no tenable monetary union without budgetary union. In a continent where the temptation to withdraw is growing, this appears to be a challenge. Nonetheless, it’s the condition for the survival of the euro.”

Italian Economics Professor Donato Masciandaro writes in Il Sole 24 Ore, “Draghi couldn’t have been clearer: the later the necessary fiscal and structural policies come, the less effective monetary policy will be…Such a decisive statement should make everyone reflect. The [European] Union is like a bogged-down machine. It has at least four traction wheels – currency, taxation, competition and labour – but only one of them is working. In such a situation, the machine risks going under.”

Italian journalist Danilo Taino writes in Corriere della Sera, “[Italian Prime Minister Matteo] Renzi is a lucky guy, since no [Italian] Prime Minister ever got this sort of help from the ECB. This means, however, that [Renzi] won’t be able to ask for anything else from Draghi. The ECB President has reached the extreme limit – except for a difficult, potential government bond-buying programme. From now on, everything is in the hands of governments.”

One interesting take away, particularly from the articles from around the eurozone periphery, is that there seems to be a renewed push for measures such as further budgetary union and debt-pooling. It looks as though there is a growing acceptance of the limitations of ECB action, and the continued flaws in the Eurozone architecture – something which we have long warned of.

ECB acts as expected, now the waiting game begins

For anyone following twitter yesterday around the ECB’s announcement and press conference it would seem as if we have just had another ‘whatever it takes’ moment (when ECB President Mario Draghi promised to backstop the eurozone).

However, stepping back for a moment and it becomes clear that the ECB acted more or less as expected and some would argue has done the minimum necessary to retain its credibility and not be labelled an ‘all talk’ institution.

Sure, the package of measures looks more impressive when strung together but as we discussed in detail here and here, few if any of them address the crux of the problems in the eurozone which are depressing inflation and growth (delayed impact of internal devaluation, rebalancing of various economies, recapitalisation of banks and the breakdown of the eurozone’s cross border financial system).

All that said, there were a few more subtle and interesting takeaways from Draghi’s press conference.

Unanimous support is impressive but unlikely to apply to further easing
Draghi stressed that the support for this entire package of measures was unanimous. This is quite surprising given the previous Bundesbank opposition and does add weight to the strength of the decision. That said, just because unanimity was agreed here does not mean it can be easily translated into support for much stronger action such as asset purchases. In fact, Draghi’s hesitancy to talk about such a programme in more depth and the ECB’s willingness to push ahead with one suggests a lack of consensus on the issue. Furthermore, the outcry in Germany has already begun and will likely make central bankers think twice about stronger easing action.

Draghi insists the ECB is not “finished”, but its mighty close
Over the past year, Draghi has waxed lyrical about all the tools at his disposal and we have analysed them all in detail – see here. However, with this package of measures he has come close to emptying his toolkit – he admitted as much on the rate side saying that, for all “practical purposes”, the lower bound has been reached.

True, he has pulled out many of the smaller tools and retains the big sledge hammer of asset purchases (Quantitative Easing through buying either private assets or government bonds) but the bar to take such action remains high and gaining support for it remains a huge challenge. Pushing the deposit rate further into negative territory is also unlikely to work as banks will simply begin hoarding hard cash – this of course has some cost in terms of storage and security but it will not be more than a fraction of a percent. Finally Draghi stressed that this package could take some time to have any impact, between three and four quarters (9 – 12 months), suggesting that the ECB is now in wait and see mode as the emphasis falls on governments and the bank stress tests to help push along the economic recovery.

Impact of long term lending operations relies on cross border lending being revived
As the useful chart to the left shows (from Morgan Stanley via FT Alphaville) the amount which banks can borrow is again limited in countries which need it (the periphery) due to their already underdeveloped markets in lending to small and medium sized businesses. The technical structure for the TLTRO (pronounced Tel-tro) does allow for them to borrow more if they lend more but this will take some time. Ultimately, the target seems to be to encourage banks in the core to lend to banks and businesses in the periphery – this fits with the theory of the negative deposit rate which should encourage a search for yield. Rebuilding the cross border system in the eurozone remains a huge task.

Another potential question which arises is whether the end of sterilising purchases made under the Securities Markets Programme (SMP) will raise any legal issues or challenges in Germany and whether it will impact the judgement of OMT sterilisation.

In the end, the ECB has made its play and will likely now give it time to pan out. It will continue to provide dovish statements and may even talk up asset purchases in the future but it will urge patience in waiting to see if these measures have the desired impact.

Have borrowing costs in the eurozone periphery come down too far, too fast?

Over on his Forbes blog, Open Europe’s Raoul Ruparel asks: is there a bond bubble in peripheral Europe? The thurst of his answer is that, while there are good explanations for why costs have come down so far and so fast, they could certaintly have side effects, not least because people misinterpret the reasons for the move. The full post is here, but below are the key points:

What is driving this and is it a bubble?
There are three key factors at work here:

1. ECB President Mario Draghi’s promise to do “whatever it takes” to protect the euro combined with the unlimited bond buying policy of Outright Monetary Transactions (OMT) has driven borrowing costs down since mid-2012. This effect has been amplified by the expectations of further ECB easing, particularly some form of Quantitative Easing (QE), which would bring yields down even more.
2. There has been some success in terms of eurozone reform, particularly with the successful end to the Irish and Portuguese bailouts as well as these countries’ return to the markets, along with Greece. The eventual agreement on banking union and other aspects of trying to correct the structural flaws in the euro (although I believe it is far short of what is needed) has also contributed to the positive sentiment.
3. Possibly the most important factor though is the very low inflation in the eurozone (and even deflation in some countries). Over the past six months this has pulled the borrowing costs across the eurozone down.

This final point is driven home by looking at the rough and ready version of the ‘real yield’ on ten year debt in Europe (10yr yield minus HICP inflation). As the graph below highlights*, when this is done the UK actually borrows at a real rate which is 2% below Ireland’s.

Could this present a problem? (Hint: Yes)
While the process of collapsing bond yields in peripheral Europe is explainable it does still present some serious causes for concern.

• The huge demand for peripheral bonds does seem to have gone too far with respect to the economic fundamentals of these countries. Debt levels have continued to rise – exacerbated by low inflation – while many countries are barely posting any economic growth.
• More concerning though is that this creates very perverse incentives. Many governments can already be seen professing the success of their policies, citing falling borrowing costs and buoyant financial markets. In reality, these are much more down to the ECB and inflation effects mentioned above.
• The risk is that complacency seeps in (some of which can already be seen) and that the reform process in these countries stalls. Italy and France are prime examples of this. While the European Commission does have additional powers now to encourage further reform, when push comes to shove there is little it can do to force reform on an unwilling political class and population, particularly one with low borrowing costs.
• As detailed here, the banking union looks insufficient to break the sovereign banking loop in the eurozone. The efforts to improve the structure of the eurozone have slowed, the risk is they will grind to a halt until the threat of a crisis returns.
• The performance also looks strange relative to countries such as the US and UK which have always borrowed in their own currency for which they are solely responsible and have clear fiscal and central bank backing. Even with the changes to the euro structure and the ECB promises it’s hard to say that, in another crisis, the same issue wouldn’t arise with regards to a comprehensive lender of last resort (let’s not forget, the OMT comes with plenty of conditions and is limited in scope). Even though accounting for the inflation impact, the difference in risk between peripheral eurozone countries and the likes of the US and UK does seem to be being underestimated.

Ultimately, the crisis highlighted that too much price convergence without economic convergence and reform in the eurozone can actually be a bad thing, with resulting perverse incentives and negative outcomes. While the price action in peripheral bonds might not yet count as a ‘bubble’, investors and politicians would do well to remember these lessons when interpreting the record low borrowing costs.

ECB preview - ECB may take limited action but shy away from serious intervention

As we noted last month, a lot has been pinned on the March ECB meeting, with the release of new data potentially facilitating further easing action.

But on the eve of the meeting, analysts remain split, although the sense is that the pressure for significant action is easing. February’s inflation data came in above expectations, with core inflation (removing the effect of short-term moves in energy and food prices) actually at 1% - still very low but well above expectations. We’ve also seen positive PMIs (indicators of private sector business activity) across the eurozone and in some of the struggling countries, although France remains behind the curve.

With that in mind, it looks as if the ECB will shy away from taking a major decision on Quantitative Easing or a negative deposit rate. These remain drastic actions which the ECB is clearly unsure about, and with good reason. It’s not clear what the side-effects would be of such action or that it would actually feed through to tackling low inflation in the periphery or boosting lending to the real economy (and therefore economic growth).

There are a few other options on the table. Another, more targeted long-term lending operation (LTRO), or purchases of private sector assets, probably packaged bank loans (asset-backed securities). These are possible and more likely than the above, but for reasons discussed before, would also be quite a big step by the ECB.

The most likely options remain a token rate cut (i.e. one without an accompanying cut to the deposit rate), a further extension of the unlimited fixed rate liquidity provision and the end to ECB sterilisation of the Securities Markets Programme (SMP) bond purchases. We have outlined before that, at this stage, a rate cut makes little difference as the transmission mechanism is broken, at least to the areas where the impact of the cut would like to be felt. Extension of the liquidity provision is also broadly inferred and was always expected to go on as long as is needed, in line with the forward guidance given.

We’ve yet to discuss the end to sterilisation, so we lay out a few points below.

As a recap, the SMP was a programme launched in 2010 to purchase government bonds on the secondary market and bring down borrowing costs for certain countries (which were hampering the transmission of monetary policy). The sterilisation process sees the liquidity introduced by these purchases absorbed by the ECB, through the issuance of corresponding amounts of one week fixed-term deposits with an interest rate of 0.25%.

ECB SMP sterilisation total amount (€m)

Why take this measure?

• The idea is that ending the sterilisation would free up the €175bn in liquidity currently pledged to the ECB. This will counteract the recent decrease in excess liquidity in the eurozone and should encourage banks to lend this money out rather than simply posting it with the ECB.
• From a political perspective, this is also one of the least controversial actions since it has been endorsed by the Bundesbank and should be fairly easy to get support for at the ECB Governing Council.

Will it have any impact?

• It is unclear, but we are not overly hopeful. As the chart to the right (courtesy of Commerzbank) highlights, the earlier tensions in money market rates have eased. This means the impact will be limited.
• Ultimately, it depends on what banks decide to do with this money. The ECB deposits were a very safe investment with a decent return given the ultra low rates around at the moment. Our feeling is that banks will want to continue to search for equally safe assets rather than take on much more risk for a similar return over a short period. This could actually acerbate the demand for quality short term assets, particularly core ones, in the eurozone.
• Despite some failings in the sterilisation (shown by sharp deviations in the graph) demand has been fairly solid, although whether this is due to demand for safety or a decent return is unclear.
• The fixed-term deposits are also eligible as collateral for the ECB’s lending operations. It’s not clear if they have been used for this purpose, but if they were, this could further limit the impact in terms of boosting liquidity.

Ultimately, ending SMP sterilisation would be a token compromise measure. Its greatest use is probably as an indicator of an on-going willingness to ease if needed, and of the ability to compromise on the issue from the Bundesbank side. 

The European Commission's new economic forecasts: Fragile recovery continues, but problems remain

The latest Commission economic forecasts are out and the theme of a broad but still fragile recovery (combined with some gentle self-congratulations on the success of the current approach) has been continued. For the most part the forecasts are not hugely different from the Autumn 2013 ones, which we covered here.

We won’t do a country by country run down again, since little has changed. But we pick up on a few general themes below.

Inflation forecast cut
A metric which everyone is watching at the moment is inflation. As we have discussed before, March has been pegged as a key meeting for the ECB and is expected to be a defining choice over whether the bank takes more action to tackle inflation. The EC has cut its forecast for inflation from 1.5% to 1.1% for this year while last year’s has been revised to 1.3% from 1.5%. Despite the language being quite strong on inflation remaining low and subdued, these forecasts aren’t far from the ECB’s own and are unlikely to push them one way or another when it comes to taking further action. The graph also highlights that the view of core inflation (without energy or food prices) been on a slow decline for some time but is expected to melt upwards over the coming years. Again this fits with current ECB thinking rather than bucking against it.

Spain and Italy – diverging forecasts, but plenty of common problems
One of the more surprising points is that Spain has got the most substantial upgrade of all the big eurozone countries – with its 2014 growth forecast raised from +0.5% to +1%. At the same time Italy is the only big eurozone country whose growth forecast for this year has been revised downwards – from +0.7% to +0.6%. Similarly, on the unemployment side (while Spain remains in a much worse position) the forecast has improved somewhat for Spain and worsened for Italy. In any case, both continue to struggle with their large debt loads (more below), although new Italian Prime Minister Matteo Renzi might take the less than optimistic forecast as an important reminder of the reforms he needs to pursue, not unlike the ones Spain has undertaken…

Debt remains a problem in the eurozone
By 2015, seven eurozone countries are forecast to have public debt levels above 100% of GDP – Belgium, Ireland, Cyprus, Greece, Spain, Italy and Portugal. As the report warns, this debt overhang could become a drag on medium term growth, particularly when combined with other factors such as the knock on effects of years of depressed investment, high unemployment and falling productivity.

Borrowing costs for SMEs have come down but remain divergent in eurozone
As the graph highlights, there has been some improvement over the past few months. That said, borrowing costs for firms in France and Germany remain substantially below those in the periphery countries. Given the importance for SMEs, particularly in Italy and Spain, it is difficult to see a strong pick-up in economic activity or employment until SMEs can fund themselves effectively at reasonable rates.

Transition from export driven growth to a more balanced recovery
The EC suggests that the recovery is and will become more broadly balanced. As we have warned, particularly with regards to Portugal, becoming overly reliant on exports can be dangerous as it’s not clear that there will be sufficient demand to pull the economy out of its slump. That said, the Commission doesn’t entirely provide convincing ground for the significant turnaround in domestic demand and investment which is expected. With firms and households still weighed down by significant amounts of debt in much of the periphery and borrowing costs remaining high, it’s not yet clear that this can take place as quickly as is hoped. As the graph below shows, the turnaround needed is substantial.

Labour market continues to lag behind
Even if you buy into other parts of the recovery, it’s clear it hasn’t yet come close to improving the serious unemployment problem in much of Europe. Divergence is also expected to remain with many of the peripheral countries having incredibly high unemployment for the foreseeable future (well beyond the timeline of these forecasts).

And finally, seriously, what’s wrong with Finland? This data marks another bad day for the Finnish government, with the Finnish economy forecast to grow by only 0.2% this year, the slowest level behind Cyprus (-4.8%) and Slovenia (-0.1%), both embroiled in the eurozone crisis.

Are further falls in inflation putting more pressure on the ECB to act?

Friday saw the release of the flash estimate for annual inflation in the eurozone in January. It dropped further to 0.7% - well below the ECB’s target of 2%.

The initial reaction was that this will increase pressure on the ECB for action at this Thursday’s Governing Council meeting. While that is true on the surface its worth keeping another couple of points in mind.

• As the graph above shows (click to enlarge), much of the recent decline has come from changes in energy and food prices. Core inflation, excluding these two factors, has been relatively stable since October and has been on a gradual decline since spring 2013.
• Now of course, many will point out that energy and food are important components of real world costs and therefore should not be discounted. This is a valid point, but here we are looking for insight into how the ECB takes its decisions. Generally, the ECB will be less concerned over short term moves in energy and food prices and is therefore less likely to take action off the back of this.
• The main part of the decline took place last year and has been happening for some time – this is likely already accounted for in the ECB easing efforts.
• While the inflation data may not push the ECB to act, there are plenty of other concerns. The turmoil in Emerging Markets could push the ECB to provide an additional liquidity buffer against any shocks. While this morning’s PMI manufacturing data was actually very positive for the eurozone, data on lending to the real economy and growth of the money supply is less so.

As we have suggested before, some further easing is looking likely. The real question is when and how? The data suggests to us that the ECB will wait until its March meeting and its updated inflation forecasts to make a judgement – but then again it went a month earlier than expected in November.

As for how, the most likely tools remain some form of targeted LTRO and/or purchases of bank loans but both programmes would require significant work and have numerous shortcomings, as we have already noted.

A peek inside the ECB’s toolkit

Despite being barely a month into 2014, there have already been countless column inches written about the ECB and President Mario Draghi’s potential actions during 2014 (mostly to tackle the ‘deflation ogre’).

Is the ECB toolkit empty?

As we have noted before, while the ECB has an extensive toolkit in the case of an acute crisis, it has so far struggled to find the right tool (if one exists) to help promote lending to the real economy and therefore economic growth.

The favoured policy, widely cited by commentators and mentioned by Draghi previously, is some form of targeted liquidity scheme linked to lending to the real economy – along the lines of the Bank of England's 'Funding for Lending' scheme.

Such an option remains possible, but as Bundesbank Chief Jens Weidmann has pointed out, difficult to implement. We have noted this before, but, given that the ECB is already running unlimited liquidity at near zero interest rates (on loans up to three months) it’s hard to see that there would be huge demand for longer loans tied to specific lending requirements.

Over the weekend, speaking at the World Economic Forum in Davos, Draghi revealed another potential policy – ECB purchases of bundles of bank loans (aka. securitised bank loans or asset backed securities).

Is this a real option?

• The ECB has previously purchased covered bonds and government debt on the secondary market. Hence, securitised bank loans should be possible in theory.
• However, as Draghi himself admitted, the market for such securities remains seriously underdeveloped in the eurozone.
• The idea seems to be in its early stages, and probably requires a lot more discussion within the ECB.
• The move would likely face significant opposition within the Bundesbank, and Germany more generally. This would probably be focused on the risks involved in such asset-backed securities, which are often opaque and continue to have a negative connotation due to their role in the financial crisis.
• These are the reasons why Draghi has previously shied away from direct action in this area, instead suggesting that it is an area for the European Investment Bank (EIB) to act. There have been comments suggesting that work was underway on a joint programme, but nothing ever emerged.

Would it be effective?

• At the moment, no. The market remains significant underdeveloped. According to the Association for Financial Markets (AFME) the outstanding securitisation market is €1,545bn - only €131bn of which related to small business loans, while the very large majority of which relate to Retail Mortgage Backed Securities (RMBS) probably from the UK and Netherlands. While Draghi is probably right in his suggestion that it would develop in response to any ECB action on this front, it has a long way to go.
• Data from AFME give some flavour for the securitisation market in Europe. As the tables below show, the market remained small over the past few years, with less than a fifth of last year’s issuance relating to lending to Small and Medium-sized Enterprises (SMEs).

• Furthermore, in terms of the location of collateral, the markets remain very underdeveloped in the countries which the ECB would likely want to target. The UK and Netherlands account for a large chunk of the European market. Italy and Spain do have some market presence, but it remains small compared to the size of their economies (although this is true for the sector in general).

• The final point to note is that the structure for such securities remains opaque and undefined. Given that they are bundles of various technical products, they will always be difficult to value, and while credit rating agencies have improved their processes, questions will still be asked as to whether their ratings truly reflect the risk and value of these products.

While this option looks to be some way off then, the fact that Draghi felt the need to bring it up will likely encourage the view that the ECB will take some further action in the coming months.

ECB preview – ECB edges towards rate cut as inflation drops

Interest has grown in this month’s ECB meeting, after inflation surprised on the downside last month, falling to 0.7% - far below the ECB’s 2% target.

In all likelihood, the discussion will not be too different from previous monthly meetings, but there are a few points worth flagging up.

A rate cut in November or December?

• The consensus is now moving towards a rate cut this month, or more likely next month. As we pointed out before, this will have little impact given that rates are completely detached from the ECB’s main interest rate and the transmission mechanism remains broken in much of the eurozone. Ultimately, it is a signal that the ECB is keen to keep loose monetary policy. 
• The ECB, though, could well hold back for a few reasons. Firstly, it probably wants to see how the nascent recovery in the eurozone develops. Secondly, it knows this is probably its final rate cut and wants to time it correctly. Thirdly, its medium-term forecast is for inflation to recover (although this is likely to be revised downward in December). 
• FT Alphaville also highlights the interesting point that, given that this will likely signal the end of rate cuts, the response could even be a slight increase in market rates.

A new LTRO in the New Year?

• The shrinking of the ECB balance sheet continues, as eurozone banks are repaying the LTRO loans. Liquidity is dropping rapidly in the eurozone and short-terms rates have edged up somewhat – creating a de facto tightening of ECB policy. This is exacerbated by the continued easing bias by the other global central banks.
• That said, the previous LTROs have served to increase the sovereign-banking loop. They also remain a blunt tool since the amount of liquidity injected relies on demand, while the prospect of this lending being stigmatised under next year’s stress tests could discourage banks from tapping it.

Euro strength weighs on the ECB’s mind

• The strength of the euro in recent weeks, particularly against the dollar, has been covered widely with an increasing number of investors and politicians calling for action on this front. 
• Although the ECB has stressed that it does not target the exchange rate, it has shown before that it certaintly considers it. Draghi has shown a willingness to ‘talk down the euro’ previously, and is likely to try and do so again. However, turning this into lasting success is tricky and clamour for more concrete signs could increase.
• Failure to address the issue also leaves the currency open to volatility, as markets struggle to interpret the ECB’s vague signals and balance them with more defined ones from other central banks.

What to do with the deposit rate?

• This is another aspect weighing on the ECB’s collective mind. As we pointed out before, a cut to negative territory could have many unintended consequences, and is unlikely to be risked in anything but the worst circumstances. Still, the desire to maintain some ‘corridor’ between the regular rate and the deposit rate could make the ECB think twice about cutting rates at all.

As the above suggests though, we stick by our view that the ECB does have limited tools to help promote economic growth. This meeting is also likely to be another test of its new communication policy and whether it can really have lasting market impact. Ultimately, though, pressure for some concrete action from the ECB is likely to increase as long as inflation remains subdued.

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.

Open Europe publishes Commission regulation which seeks to move Libor oversight to Paris

As the FTT threat wanes (a sizeable victory for the UK we might add) another battle threatens to flare up in the wider debate about financial regulation within the EU – albeit a smaller but still concerning one.

As the FT reported yesterday, there is a regulation in the pipeline in which the Commission proposes significantly stepping up the regulation of benchmark indexes and rates used in financial markets and contracts. In particular though, it proposes moving the supervision of key benchmarks, such as Libor, to the European Securities and Markets Authority (ESMA).

As we did consistently throughout the FTT debate, we have got our hand on, and have exclusively published these latest plans – see here.

What are the key points of the plans?

• The main focus of the regulation is to move the oversight of thousands of benchmarks used in trillions of dollars’ worth of financial contracts and instruments away from self-regulation (or from being unregulated) to being under direct supervision.
• However, importantly, the proposal sees the most important benchmarks, such as Libor and Euribor, being supervised by ESMA since, in the Commission’s view, fractured oversight harms the single market.
• The plan also looks to step up the legal liability involved in the benchmarks (making any manipulation a criminal offence across the board) but also allowing supervisors more control to compel participation in certain benchmarks and allow for consistent oversight.

Open Europe's take on the plans

• First, let’s make it clear that Libor has patently failed and needs to be reworked. Everyone accepts that. However, the UK is currently in the midst of doing just this, following the recommendations of the Wheatley Review earlier this year (which happen to line up closely with those of IOSCO the international body looking into this issue).

• This makes the proposal particularly badly timed. It is ultimately based on an outdated view of Libor which is already under review and beign changed. In fact, if you look at the substance of the UK review and the international recommendations (upon which the Commission based its proposals) they line up fairly closely with the EU plans other than where the control rests.

• The Commission justification for needing an EU regulation on this issue also seems a bit of a stretch to us. Sure, some of these benchmarks are used in the rest of Europe but they are also used all over the world. However, all those involved in Libor will have a presence in London. As is well known, the large majority of European trades which involve many of these benchmarks will also take place in London. Why the oversight should not be focused there is still not clear.

• There is also rightly a significant concern over the rigidity of the Commission proposal. Firstly, the plan to base all submissions off actual transactions seems unrealistic. This issue came up in the initial debate about reworking Libor – ultimately, there are not nearly enough interbank transactions to actually produce the rates for the ten currencies and the 15 different maturities which Libor currently covers.

• Linked to the above point is the concern about the ability to force banks to comply and take on significant legal and regulatory responsibility for their submissions. Ultimately this is a large liability to take on off the back of what is still an estimate.

• This is a very technical subject. It is almost impossible to lay down all the rules and structures for how various benchmarks should be judged. Surely, the approach varies wildly depending on the benchmark and may even change depending on the wider economic and financial circumstance. This raises two concerns: the rigid framework presented may leave substantial grey areas but more importantly a lot of power for setting the technical details will be left up to the Commission, after the political negotiations have finished. As we saw with the bankers bonus’ regulation this can has a very large impact on the scope and practical implementation of the rules.

• It sets a worrying precedent, especially as the ECB is set to take over as the single eurozone supervisor and the potential for eurozone caucusing on this issue increases. As we saw with the regulation over Credit Rating Agencies (CRAs) over the last few years this can be dangerous. The initial drafts of the CRA regulations are quite similar to this one, however, worryingly it has extended and escalated over time. The UK government should look to tackle this issue head on to avoid a similar scenario.

Overall then, although Libor needs to be reworked and better supervised, it’s not clear why this needs to be done at the EU level, particularly when the UK is in the middle of its own reworking. The rigidity of the proposal also raises questions about its practical implementation. At the very most, there could be an EU directive on this issue setting out a broad approach with room for national flexibility. Ideally though, this should be left to individual states where the rules can be drawn by those who are most impacted by them and closer to the stakeholders. This should of course be combined with on-going global cooperation as is already underway.

Thankfully, it seems we are not the only ones with these concerns and some watering down of these rules already looks likely.

Conflict of interest (rates): clamour for ECB rate cut grows but Germany remains wary

The last few days have seen a shifting of consensus in the ECB rate cuts debate.

Recent economic data in the eurozone has been particularly bad, with private sector activity slowing more than expected. However, potentially more importantly, this effect has been seen in Germany and some of the stronger northern countries as well.

In response to this data most banks and analysts shifted their expectations and now forecast an ECB rate cut in May or June.

The thinking goes that, a slowing economy in these countries (and therefore lower inflation) will give the ECB more scope to cut rates without fear of it having disproportionate effects on the stronger economies. After all, the ECB is meant to find a balance that suits all countries (although it rarely does, hence the flaw of one-size-fits-all monetary policy).

As always on central banking issues though, Germany remains the key player.

German Chancellor Angela Merkel has now waded in to debate about possible ECB action. Speaking at the conference organised by Sparkassen association this morning, Merkel said:

"The ECB is obviously in a difficult position. For Germany it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing."

"If we want to get back to a bearable interest rate level, then we have to get over this internal division of the euro zone."

In a country where central bank independence is worshiped, politicians usually stay well clear of commentating on monetary policy, so Merkel's comments are quite extraordinary. Perhaps they were prompted by increasing noise coming out of the French government over what it sees as the need for the ECB to take a more activist approach, despite a genetlemen's agreement between the two governments not to discuss ECB policy in public.

German ECB board member Joerg Asmussen also weighed in yesterday saying:

"Monetary policy is not an all-purpose weapon for any kind of economic illness…Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed.

At the same time, rate cuts would further relax already unprecedentedly easy financing conditions in the core. This is not per se a problem – but interest rates that are too low for too long can eventually lead to distortions. In particular:

• to a misallocation of resources, which ultimately leads to lower potential growth,
• to excessive capital inflows into a number of emerging economies with exchange rate effects and credit risks,
• and to reduced incentives for governments, banks, and corporates to adjust."

For numerous reasons, it seems that a rate cut should not be taken for granted after all. Asmussen is  right that given the broken transmission mechanism and market fragmentation, any cut will have limited effect on the economies where it's meant to provide a boost. But more importantly, there is still a view in Germany that lower rates could have a harmful effect particularly by pumping up an asset and property bubble – similar to those seen when newly low ECB rates were introduced in the south during the euro's creation.

That said, the wave of voices calling for some ECB action is growing, particularly given the wider debate on austerity. It will be tricky to balance this with the demands of the northern countries.

Once again the ECB finds itself stuck as the main player in an increasingly political debate.

Revising the Greek bailout: Two more years of extend and pretend?

Open Europe published a new flash analysis on Friday, which looks at the prospects of a revision to the Greek bailout. It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

The €28.5bn comes from: an extra €14bn due to slower deficit reduction, an extra €12bn from reducded privatisation receipts and an further €2.5bn from increased government arrears (unpaid bills).

We examine six key options for filling this gap:

1. A reduction in interest rates - which looks very likely but could only deliver €2bn - €3bn.

2. Increased short term debt issuance and more austerity - this looks possible and could deliver anywhere between €15bn - €20bn.

3. Extending length of loans to Greece - unlikely, it could raise €9.1bn in the short term, but on net it would give zero reduction.

4. ECB forgoing interest and/or profit on its Greek bonds - looks very unlikely, but could yield €1.15bn - €2.3bn (interest rate cut) and/or €14.25bn (forgoing profit).

5. Bond buybacks - again very unlikely, but it would mark a much larger step than simply covering the funding gap, as it could deliver €45.65bn overall and €17.15bn after the two year extension is paid for.

6. Write-down original eurozone bilateral loans -  this would be a huge step and could provide €26bn to €52bn but looks very unlikely to be approved, especially as it would support in national parliaments. 

Overall then, its hard to see how the gap will be filled without some larger decision being taken over the future of Greece in the eurozone. To read the full note, click here.

Draghi's Den

It’s been a whirlwind entrance for Mario Draghi as ECB President and today’s meeting of the Governing Council was seemingly no exception. The key decisions which came out of the meeting were much what we expected, although with a few twists, while more importantly Draghi tackled some of the interesting problems facing Europe fairly bluntly (for a central banker anyway).

Key decisions

1) 0.25% interest rate cut: Essentially needed to be done since markets had come to expect it and the prospects of a eurozone recession next year are looming large. Probably highlights previous rate rises as a mistake, at least in retrospect, has been shown up by eurozone leaders failure to tackle the crisis. The failure of a single monetary policy looks to have been papered over while eurozone contraction sets in, but when/if Germany starts growing quickly again (relative to the rest of the eurozone) Draghi will have some much tougher decisions.

2) Long term liquidity to banks (3yr loans): Widely reported that banks would struggle to secure long term financing without such a move (have €230bn in debt maturing in Q1 2012). Not ideal given the ever increasing dependence from the banking sector on the ECB, but should be seen as a one off. Hopefully will increase lending in the broader economy but this is not assured, especially since unlimited short term liquidity has failed to do so.

3) Easing collateral rules: Greater acceptance of asset backed securities (ABS) – sounds ominous. Not ideal but does come with clear criteria and conditions. There have been indications that banks are running short of viable collateral. Without such a move, this could cause deleveraging or force banks to shift to Emergency Liquidity Assistance (ELA) which accepts even worse collateral and is more secretive. This could, however, potentially propagate the movement of poor quality assets onto the ECB’s balance sheet.

Interesting comments by Draghi

- “The ECB is not a member of the IMF”: Draghi went to some lengths to stress that the plan for eurozone national central banks (NCBs) to lend to the IMF so that the IMF could lend “exclusively” to struggling eurozone countries would not be possible. One point which has been raised is that IMF money is fungible, so the NCBs could contribute to the IMF general reserve account which could then lend to eurozone members. In any case, Draghi made it clear he’s not keen on ECB or NCBs lending to the IMF and may try to stop any proposal, even if it isn’t de jure illegal.

- “We shouldn’t circumvent the spirit of the treaty”: Draghi said this countless times. He reiterated his opposition to increasing bond purchases. He also seemed to suggest he would reject similar ideas of ECB lending to states even if they could be justified as de jure legal if they were de facto illegal and broke the principles of the treaty.

- ‘Other elements will follow’ fiscal compact comment was misinterpreted: Interestingly, Draghi highlighted his surprise that his comments last week had been taken as an indication of increased bond buying, stating that he did not mean that in anyway. He suggested that he was merely highlighting the sequence of events, in that fiscal consolidation needs to come first and can then be followed by a backstop but only through the EFSF or the ESM, the eurozone bailout funds.

So, a strong expansion of monetary policy to help the banking sector a promote growth and stability. We may not be onside with all of his measures, since they may raise long term questions over what gets put onto the ECB’s balance sheet, but they are clearly within the realms of monetary policy. Using these mechanisms is always preferable to the ECB wading into the murky world of fiscal policy.

Despite this boost, markets are likely to be unnerved by his comments during the Q&A session. Draghi essentially ruled out any ECB or NCB lending to the IMF or at least suggested he would oppose the process. He also put pay to this ‘quid pro quo’ theory that the ECB will step in and increase its bond purchases if eurozone leaders agree some fiscal integration or discipline. We have to commend Draghi for his firmness on these issues, although we still fear he could wilt in the face of the increasing clamour from eurozone leaders and their reliable inability to find any solution. But at least for now it puts the ball firmly back into EU leaders’ court ahead of tomorrow’s summit.

Bad weather on the Spanish horizon?

The crushing defeat for the Spanish government in last weekend’s regional elections, along with the seemingly infinitely escalating situation in Greece, has seen concerns over the state of the Spanish economy rear their head once more.

Though we're generally far more positive about Spain than some of the other struggling eurozone economies (some of them are over the edge already so that's a no-brainer), in our recent paper looking at the situation in Portugal, we did warn of a potential ‘perfect storm’ (a combination of detrimental economic factors) which could push the Spanish economy towards needing a bailout.

Unfortunately, it does look like that storm could be brewing on the horizon, should the numerous factors which are hovering over the Spanish economy overlap or coincide.

Firstly, as was reported last week, these elections could reveal a raft of hidden debt (the FT suggested around €26.4bn) as the new regional heads of government attempt to establish exactly how big a problem they face – and blame any ensuing issues on the previous incumbents. Although not immediately dangerous given the size of the Spanish economy, this extra debt could cause Spain to miss it’s debt and deficit targets for the year – something they would surely be punished for by financial markets.

There’s also the rising political unrest due to high unemployment and austerity, particularly among young people. If this gathers pace, support for the government's reform programme could be put at risk despite having made large strides so far. Again it is likely that a let up in the economic adjustment currently underway would see the cost of borrowing increase – given that it’s already close to 6% its not a stretch to imagine that it might break the 7% threshold (beyond which debt is seen as unsustainable) under the 'perfect storm' scenario.

Then there is the ongoing spectre of ECB interest rate increases, which will hurt because of the massive levels of household debt and the high proportion of variable rate mortgages (making home owners with mortgages highly vulnerable to increases in interest rates), as well as the weak banking sector, which continues to look undercapitalised and remains heavily exposed to the bust real estate sector. Add to that the potential contagion from other parts of the eurozone which continue to struggle. Then combine all these factors and there is a potential economic storm brewing for Spain.

The biggest threats to long term prosperity in Spain continue to be the banking sector and potential ECB rate rises, which is why the government needs to step their banking reform programme up a notch (including building up capital reserves and deleveraging the entire sector), while developing a policy to counter interest rate rises by the ECB. Pushing the EU to come up with solutions that actually deal with the eurozone crisis rather than prolonging it (debt restructuring, combined with cash injections for banks for example), wouldn't hurt either.

Despite all this, the outlook for the Spanish economy is reasonably bright at the moment, especially bearing in mind how well it has withstood the Portugal crisis so far.

But there are far too many 'known unknowns' in Spain and across the eurozone to feel comfortable, suggesting that a storm could be ahead.

The dark side of the ECB

Lots of people have been focusing on the recent ECB rate rise, but the ECB’s role in this crisis has really been determined by its other – more opaque and less publicised – role: as lender of last resort. This has got the ECB into a near untenable position. It faces huge exposure to peripheral eurozone countries, it aims to maintain price stability, but has also acted to stabilise the whole eurozone economy, and it has underwritten a bloated and inefficient banking sector with unlimited cheap money.

The ECB has lent massively to the struggling European banking sector. Although this may have been viable and necessary to halt the systemic risk from the financial crisis it is now out of control. It has propped up banks that should have gone bust and created banks addicted to ECB funding. A mechanism for reining in lending and winding down banks should have been in place from the start. The ECB essentially dug itself a hole without bringing a ladder to get itself out again.

Let’s not forget, these actions also helped fuel the sovereign debt crisis by creating perverse incentives. These banks could take on cheap ECB loans and then invest in high yielding but relatively safe assets (peripheral sovereign bonds at the time), in order to turn quick profit and increase capital. This fuelled the level of government debt and when it became clear just how bad the sovereigns' finances were, markets panicked and the debt crisis hit (but with more debt and more banks involved/exposed than before).

The ECB tried to fix this problem by throwing more liquidity at it (through its bond buying programme). This just increased its exposure to risky economies, distorted bond markets and rightly raised questions over its independence and impartiality (not to mention being potentially inflationary).

Lastly, the ECB has overseen the build up of huge imbalances in the eurosystem of central banks. Some, like Ireland or Greece, borrow huge amounts but contribute little. The loans to these countries are underwritten by other central banks in the system, making them even more exposed to a peripheral default.

The ECB has played a huge role in the cycling of debt around the eurozone, and put itself in a very exposed and compromising position. Its interest rate policy is massively important but the darker side of ECB policy has debatably played a more important (and negative) role in this crisis.

To be fair to the ECB this was not all of its own making, since it was forced into this situation by eurozone leaders inaction, which is further illustration of the politicisation of a once proudly independent central bank.

A Portuguese bail-out won't be enough

Over on Europe’s World we have a post on the future of Portugal. We argue that a bailout now looks inevitable but that it will do little to solve Portugal’s problems due to:

- Funding requirements topping €39.4bn this year alone, equal to 25% of GDP.
- Unsustainable borrowing costs both in the short term and the long term, as we have already noted.
- Over reliance on ECB funding - both the state and the banking sector
- Massive lack of competitiveness as well as few policy options to facilitate economic reforms and foster growth

Given the mountain of issues facing Portugal, a bailout might give the appearance of providing help in the short term, but restructuring debt and tackling the problem at its source - high debt to GDP ratio and massive amounts of private debt - will provide a much better long term solution for both the country and the eurozone. However, even so, in the absence of some serious reforms to boost the country's competitiveness, going far beyond those that we're seeing at the moment, Portugal may find itself in this position again before too long.

You can check out the full article here.

The cost of dignity

Yesterday, Portuguese Prime Minister Jose Socrates said:

"[Portugal] would lose its prestige and (its) dignity of being able to present itself to the world as a country that succeeds in solving its problems [if it asks for a bailout]."

Today, Portugal auctioned off €1 billion in 2 year government bonds, but the Portuguese really had to pay this time. The interest rate was 5.99% which, for 2 year borrowing, is an exorbitantly high cost. Keep in mind that even with the punitive interest rates of 6% for 3 years, the current bailout loans now look relatively good value for the Portuguese.

Oh, and just in case you thought things looked better down the line: 5 year rates reached 7.82% and 10 year hit 7.70%.

The 10 year rate has been above 7%, the threshold widely accepted as being unsustainable, for 24 consecutive days; Greece and Ireland lasted 13 and 15 days respectively before asking for a bailout. The real question now is not if Portugal needs a bailout but when, and will it be enough? Surely a restructuring would do more for its long term economic stability at this point.

In any case it looks like prestige and dignity are going to hit the pockets of Portuguese taxpayers hard until a decision is made.

Start with the man in the mirror

In an opinion piece in the FT published the other day, Klaus Regling (see photo), the chief executive of the eurozone's temporary bailout fund attempts to counter critics of the common currency.

The unelected official, who looks after €440 billion in loan guarantees, argues that "EMU’s critics will eat their words again", explaining how the euro will be saved through more budget discipline and sounder economic policies in member states.

He gives the example of Latvia, writing:

Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg – in line with advice from the commission – it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside “experts”, who always seem to know what is good for Europe, should take note.

He is right that "internal devaluation" can indeed restore competitiveness, although it's questionable whether politicians in countries such as Greece are willing to follow in Latvia's footsteps on this one. Of course Regling omits to mention that, in the case of Latvia, the country's reduced competitiveness was driven by a bust in the real estate market, in turn partly brought about by Latvia's euro peg.

An article on Global Property Guide makes clear that the damage was inflicted by the EU's pressure for a euro-peg on the Baltic country, which isn't eager to go against EU guidance, given that its EU membership is also a matter of geostrategic security.

From 2004 to 2007, property prices doubled, tripled or even quadrupled, just to fall in December 2008 by a crazy 41% in real terms from a year earlier. The euro peg had first pushed mortgage rates disproportionately low, boosting excessive demand for real estate. The following adjustment through increased rates bankrupted many Latvian citizens who saw the value of their investments drop.

In his defence of the monetary union, Dr Regling doesn't mention any cure to the eurozone's most fundamental problem - its one-size-fits-all interest rate policy - which has a tendency to facilitate booms and busts (though not the only factor ). Even the Celtic Tiger, Europe's champion of competitiveness, was floored by these mechanics, as low interest rates created a real estate boom and bust, poisoning systemic banks and bringing the country to the edge of the abyss (despite the fact they passed the EU's stress tests only last summer).

As the German economy continues to boom, there will soon be calls in Germany for the ECB to jack up interest rates in order to prevent inflation. But this, in turn, will seriously undermine Spanish and Irish efforts to get their economies back on track - and potentially off set many of the hard-fought reforms that the two countries are pushing through at the moment.

No matter how much of taxpayers' money EU leaders will put on the table, as long as there really isn't a European economy, Dr Regling should continue to expect criticism of EMU's flawed construct.

And in terms of lashing out at the "outside experts" who know what's "good for Europe", we suggest Mr. Regling starts with the man in the mirror. As Ambrose noted in yesterday's Telegraph,

Perhaps it is unkind to point out that Dr Regling was the European Commission's director-general of economic affairs from 2001 to 2008, more or less spanning the incubation period of the catastrophe now at hand. To borrow the immortal line from Watergate: what did you know and when did you know it?

Going Dutch or going bust

Last week, three associations of Dutch pension funds' issued a quite startling warning to the Dutch Parliament: "If interest rates remain so low" they said "the the entire pensions system will be undermined”, adding that insurers could take a serious hit as well.

Thing is, Dutch pension funds are stuck in a tricky dilemma: they're promising their savers annual returns of 3.75 percent or more, but long term interest rates are substantially lower than that (down to 2.13 percent in Germany).

This has led to a big uproar in the Netherlands, as it emerged that as many as fourteen Dutch pension funds could be forced to backtrack on their obligations - for the first time ever. This, in turn, would result in a 14 percent loss for some 150,000 Dutch pensioners. The Dutch pension system is very much designed around a large number of private pension funds, which traditionally have yielded good returns for Dutch citizens - so the pain would be felt.

The Dutch National Bank, effectively working under the ECB, argued that the pension funds had themselves to blame for the problems. But Albert Roëll of Kas Bank blamed the situation on the continued low interest rates and the cheap money the ECB has distributed to banks, in the wake of the sovereign debt crisis in the eurozone.

The Dutch government has now rejected demands from the pension funds to relax capital standards (which they argue would be one of the few ways to address the problems. Adjusting interes rates could have been another, if the Netherlands hadn't given up its control over interest rate policy) .

So what do we see?

- The Dutch pension system, which is world famous for its large share of private pensions, is coming under strain because of the ECB's low interest rates. These rates are in many ways now intended to serve struggling periphery economies in the eurozone and big banks who did unwise investments in these same economies.

- In turn, Dutch pension funds are forced to take on more risks (holding less capital) in order to cope with these strains. The alternative is to cut returns, meaning less money for the country's pensioners.

- Another example of the problems with a one-size-fits all monetary policy in an area with such diverging economies as the eurozone.