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 preview - Dovish Draghi to double down on easing?

The European Central Bank (ECB) holds its monthly meeting in Frankfurt today - the day after ECB President Mario Draghi's 67th birthday.

As usual, Open Europe's Head of Economic Research Raoul Ruparel has published a preview on his Forbes blog, explaining what we may expect from today's meeting.

Here goes:

Following ECB President Mario Draghi’s dovish speech at Jackson Hole last month this week’s ECB meeting has taken on new importance. This has been further enhanced by the recent Eurozone inflation data which put annual CPI at 0.3% in August. The headline figure hides some of the story with core inflation actually rising to 0.9% (from 0.8%) but the ECB’s previous inflation forecasts have begun to look increasingly out of line with reality.

However, those expecting a big move are likely to be a bit disappointed. As I pointed out last month, it is almost nonsensical for Draghi to unveil new measures before his previous policies have been implemented. I am thinking specifically of the TLTROs (targeted long term lending operations) the first of which will only be conducted on 18 September. Any big announcement now could undermine the predicted take up of these measures – which clearly remain the ECB’s preferred approach for injecting further liquidity.

That being said, these measures are unlikely to make much difference since the conditions for passing liquidity on to the real economy remain very loose. They are also very unlikely to appease investors and markets which have now come to expect some significant new easing. The two key options which are on the table for this meeting are:

1. A further interest rate cut: Many will validly ask, what is the point in a further cut now? Of course it would have little to no economic impact, however, it would once again signal the dovish bias of the ECB. It would also signal a clear shift in the ECB’s position given that Draghi has previously said rates are unlikely to get any lower than current levels. It becomes another mechanism to express his commitment to further easing. There also remains scope to make the negative deposit rate more negative, although there is a cap on this since, at some point, it will be cheaper for banks to simply hold cash than deposits with the ECB.
    
2. Purchases of private sector assets – specifically Asset Backed Securities (ABS): The ECB has long telegraphed such action and it is the next obvious tool at its disposal. Whether or not it will be announced this month or in the coming months is a bit of a toss-up. It seems the ECB is not quite ready to implement it yet and has made a big song and dance about the need to adjust regulations and definitions of ABS, which are yet to fully take place. Whenever it is announced, implementation is likely to be later this year to allow the negative deposit rate and TLTROs to have time to work. I remain sceptical on the effectiveness of this policy, which I have analysed in detail on the Open Europe blog. Ultimately, the market for the transparent ABS related to SME loans remains very small in Europe and focused in the core countries rather than the periphery (where this money really needs to flow to). For example, in Q1 2014, of the €18.5bn in ABS issued, only €1.6bn used SME loans as collateral. The ECB maintains that it can and will help create the market in this area, yet with this measure having been forecast for some time, you would expect there to have been some market response already.

As with many of Draghi’s press conferences, all of this will be weaved into a dovish speech including a few key trigger words for markets – few other central bankers are as adept in their communication. As for full blow Quantitative Easing on sovereign debt, this remains someway off in my mind and hurdles remain high. Its use will ultimately be tied into developments in the fiscal and political sphere, as hinted at in Draghi’s speech (more detail on this coming in a future post). The ECB will be loath to unveil QE, which it fears can only buy time, without further commitment to reforms, a clearer fiscal approach and developments on the structure of the Eurozone which such changes will entail.

Has the ECB backed German ‘reform contracts’ for the eurozone?

In a speech in London yesterday, ECB President Mario Draghi issued a call for new eurozone rules on structural reform. He discussed it at length in the speech, but the ECB’s summary captures the key points:

The governance of structural reforms deserves as much attention as enforcing fiscal rules and should be done at the euro area level.

Structural reforms need strong domestic ownership since they reach deeply into societal arrangements. But at the same time, the example of the International Monetary Fund shows that there is a convincing case to be made for a supranational body that makes it easier to frame national debates on reform. This can shift the debate from whether to how to implement reforms, Mr Draghi argues.

The outcome of structural reforms – a higher level of productivity and competitiveness – is not merely in a country’s own interest, but in the interest of the monetary union as a whole. 

In the euro area, there is therefore a case for establishing rules on structural reform at the EU-level. While a lack of reform can threaten cohesion of the union, the recovery shows us how decisive reform can strengthen it.

Despite the lack of specific details, this has rightly evoked comparisons to the German proposals for ‘reform contracts’, which were strongly pushed last autumn and which we discussed in detail here. There are lots of overlapping ideas, including the concept that eurozone rules will help encourage ownership of reforms rather than discourage it, and that this is a logical supplement to the existing European Semester.

We have always expected the reform contracts to make a comeback in some form or another, not least given Germany's strong support for the concept, and there are other reasons to think that they may gain some further traction this time around.

While the peripheral countries have previously objected to such sovereignty transfers, Italian Prime Minister Matteo Renzi has been vocally touting the idea that countries should be directly rewarded for reform efforts. The details might differ, but conceptually he has moved closer to the Germans on this point.

There is no doubt the reform contracts will remain a hard political sell, but with the ECB’s backing and the growing desire for a proper negotiation and discussion around the eurozone's fiscal rules, as well as the broader approach to economic reform, now could be the time for the idea to make a comeback in one form or another.

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.

ECB to ease policy but impact could be limited

Over on his Forbes blog Open Europe’s Raoul Ruparel provides a preview for tomorrow’s ECB meeting at which some action to ease monetary policy is expected.

In specific terms he sees the ECB taking the following action:

1. Cut the main interest rate to 0.15% (from 0.25% now).
2. Cut the deposit rate to -0.1% (from 0% now). This will be an unprecedented move.
3. Announce a new Long Term Repurchase Operation (LTRO) focused on boosting lending to small and medium sized businesses. The term of the LTRO will be between 3 and 5 years, rates will be reduced if banks provide evidence of a pick-up in lending (see below for a useful Nomura graphic on this).

It could also decide to end the sterilisation of the Securities Market Programme purchases, creating a liquidity injection of €164.5bn and loosen collateral rules further. The ECB will likely keep asset purchases (both of private assets and government debt) in reserve but will likely reiterate that such action remains possible as part of a broader dovish statement from Draghi.

Despite some of these moves being unprecedented Raoul forecasts that the impact could be limited. This is for three reasons. First, much of it has been priced in as the moves have long been expected. Second, the impacts of a negative deposit rate and targeted LTRO are far from certain. Finally because it does not address the key problem, as he notes:

As the chart below shows (courtesy of SocGen) the biggest problem facing the eurozone financial system at the moment remains the discrepancy in lending rates to businesses in different economies. The knock-on impact of this is limiting credit in countries where the economy needs it and where it is needed to help drive inflation and growth.

It’s not clear that the rate cut, negative deposit rate or the LTRO will help close this gap. Fundamentally this gap is driven by a few factors which these issues do not address:

• Banks continue to deleverage and overhaul their balance sheets. The ECB’s Asset Quality Review and the bank stress tests are in the process of trying to put banks on a surer footing but until they are all done and dusted this process will weigh on banks actions.
• Cross border lending system in the eurozone remains fractured. Banks and investors on the whole are still not willing to lend and invest heavily in the peripheral economies. This stops the excess liquidity in the stronger countries filtering in the weaker ones. While negative rates will seek to encourage such movement by pushing a search for yield it is unlikely to override concerns over risk and the desire for safe assets.
• As recent ECB bank lending surveys highlight the problem is not just on the supply side but also the demand side. The economic overhaul, reform and rebalancing on many of the eurozone economies (both in the core and periphery) is an on-going process. Not only does this itself limit demand but it highlights that lending must be to new sectors and new drivers of economic growth rather than helping to simply prop up older sectors (here I am thinking for example in Spain of lending to new services rather than to the old real estate and construction sector).

Can the real Super Mario please stand up?

Former Italian Prime Minister Mario Monti may be out of Italian politics, but it's fair to say he still likes to talk - especially when travelling abroad.

In an interview with Belgian daily De Morgen and Dutch daily De Volkskrant, Monti seems to hint at what many Bundesbank-fearing Germans already suspected: that the ECB's pledge to do "whatever it takes" (i.e. the OMT, the new bond-buying scheme) was de facto grounded in a political decision - contrary to what the ECB's mandate dictates.

Here is what Monti said in the interview:

[At the June 2012 European Council], I have used my full negotiating position in order to get a line approved that looks boring at first glance. At 4 am, the signatures of all leaders had been provided, including the ones of [German Chancellor Angela] Merkel, of my good friend the Dutch Prime Minister Mark Rutte, and of Finnish Prime Minister Jyrki Katainen, you can say the monetary firepower from the North [...] The line established, in short, that eurozone countries who did their homework, like Italy, were guaranteed ECB support. That statement – at the highest political level – didn’t impress the markets, because the leaders did have the authority, but no money. One month later, ECB President Mario Draghi came out with his famous statement: the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. That did calm the markets, because Draghi did have the money. 

Monti is clearly trying to claim some credit - and the headline of the interview in De Volkskrant is actually "Mario Monti: the man who saved Europe". However, if Monti is right, it clearly means that the ECB's political independence was seriously compromised, since, strictly speaking, there should be no link whatsoever between a political agreement and ECB action..

Draghi's statement is one of the main reasons behind the fall in borrowing costs for countries in the eurozone periphery - some of which have yet to deliver on real economic reform. Monti may have given Draghi some of the credit - but he has also given fuel to those Germans who fear the ECB's independence is a thing of the past.

Has the ECB actually moved closer to QE?

There has been a cacophony of comments from ECB members and ECB watchers over the past few days. However, the overriding view since ECB President Mario Draghi’s press conference last week is that the ECB has now moved a step closer to unconventional action such as Quantitative Easing (QE).

This is mostly down to two factors. First the following statement from Draghi’s presser:

“The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation…this statement says that all instruments that fall within the mandate, including QE [Quantitative Easing], are intended to be part of this statement. During the discussion we had today, there was indeed a discussion of QE. It was not neglected in the course of what was actually a very rich and ample discussion.”

Second, the FAZ report over the weekend that the ECB has been modelling the impact of a €1 trillion per year (€80bn per month) QE programme. While it suggested that such a programme would only raise inflation by between 0.2% and 0.8% (not a significant amount given the cost), the simple fact it is being modelled has been enough to give markets hope.

We believe QE or similar measures have become a bit more likely, but mostly because the market now seems to expect action and if the ECB is to maintain its credibility it will need to do more than simply talk.

That said, while there may be ‘unanimous commitment’ to using such measures when needed, it’s still not clear what the criteria are for such action and it is even less clear that all members of the GC agree on when such action would be needed. Draghi was pushed on this on the first question during the Q&A session, however, he never provided a direct answer.

Furthermore, much of the coverage has suggested that QE is in fact closer because the ideological opposition to such a measure at the Governing Council (GC) level has crumbled - although we're not sure that such a clear unified opposition ever really existed.

With this in mind then, it’s worth once again pushing the point that, in fact many of the issues with further easing are practical, political and/or legal rather than ideological at the ECB. We have previously analysed each measure in detail, below is a summary and links to all those posts:

Quantitative Easing (purchasing government debt)
We have detailed the issues extensively here (but also here and here). Draghi has hinted of these practical issues before, highlighting that they need time to design the programme and gather more information. Beyond political opposition in Germany and the legal limits to ECB financing governments, there is a clear problem in that the purchases would need to split according to the ECB capital key, meaning little would flow to the periphery where the deflationary forces are strongest. Add onto this the fact that QE in other countries has not been proven to boost the real economy or even bank lending as well as that it may exacerbate the squeeze on safe assets and it becomes clear that practically and technically this would be a very difficult step for the ECB to take and is not well suited to tackling the problem of low inflation.

Quantitative Easing (purchasing private assets)
See our detailed analysis here. The thrust would be to target purchases of assets which would help promote bank lending – the main one discussed is Asset Backed Securities (ABS), particularly ones made up of loans to the real economy. However, these markets in Europe are small and underdeveloped meaning the level of assets available and suitable for purchase would be minimal. The ECB has suggested it wants this market to grow but it’s tough to force such a move, especially in the short term.

Negative deposit rate
We analysed this option here. Since then the ECB seems to have made progress on the technical implementation of such a move. That said, the impact remains very uncertain. It could further reduce excess liquidity, force money market funds to shutter and force banks to pass costs onto consumers. On the plus side it could help weaken the euro.

A targeted LTRO (similar the Bank of England’s Funding for Lending Scheme)
Discussed, with other measures, here. A fairly simply option to take, however, given that there is already full allotment (unlimited liquidity at low rates) and banks have already repaid a lot of the previous LTROs there is no guarantee there would be any significant take up or that it would filter through to the full economy.

Ending sterilisation of the Securities Markets Programme (SMP)
A smaller measure, discussed in this post. While it would stop liquidity being drawn out of the system on a weekly basis, it’s not clear that this liquidity would flow to the real economy.

Further standard measures such as rate cuts and changing collateral rules
We rounded up such options a while ago here. Given that rates are already so low and that the transmission mechanism remains broken, the impact of such moves is likely to be limited to signalling intent rather than hoping for any significant return.

Overall, nearly all of these measures face quite serious practical, technical and/or legal obstacles.

Furthermore, it is unlikely that there is any consensus at the ECB GC level of when each measure is needed or what the triggers for such action are. The obstacles are also probably viewed to be different sizes by each national central bank. All that is to say, while it may have moved slightly closer, don't yet count on QE being much more than a last resort.

Expectations and pressure mount for ECB action

This could easily be a standard monthly headline. As before the past four or five ECB meetings, the questions of deflation and further easing are once again weighing on the ECB Governing Council and the markets.

Over the past month the market has come full circle from essentially ruling out any further ECB action to almost expecting some purchases of assets (both accompanied by the respective strengthening and then weakening of the euro exchange rate).

This was topped off today with the latest inflation data which showed that inflation in the eurozone has dropped to its lowest level for five years (annual rate of 0.5%).

A couple of points to note on this data:

• While energy prices are still the largest driver of the contraction, unlike some previous months, core inflation (without energy, food prices or tobacco) has also fallen. This may encourage the view that the decreases are not simply due to short term shifts in commodity prices.
• That said, the core inflation rates remain above where they were in November 2013 when the ECB previously cut rates.
• Other national inflation data has been quite weak – Spain moved into outright deflation in March, while German inflation was running at only 1%.
• As Gavyn Davies noted on twitter, the 0.5% rate falls outside of the ECB’s March projections for inflation this year and up to 2016. This raises questions about whether the inflation rate is still on the upward path forecast. Combine this will the volatility and tendency to strengthen of the euro and the ECB’s projections do not seem to be holding up too well.

The other aspect adding weight to expectations has been dovish comments by ECB members, notably by Bundesbank President Jens Weidmann. Many believe this has “opened the door” to significant action by the ECB. Open Europe’s Raoul Ruparel addressed this issue on his Forbes blog on Friday arguing:

“The real issue from a German perspective is not necessarily that the door was ever firmly closed (or open) but that we remain someway from the QE door and to get there would require carefully negotiating some politically and legally explosive obstacles.”

He concludes:

“In the end, I think we find ourselves in a fairly similar position to last month (albeit having gone through a cycle of over scepticism and now over optimism) – further action remains possible but not yet highly likely.”

This meeting will be another one to watch but so far the ECB seems strongly wedded to its new communication and forward guidance policy, which it believes can allow greater control over rates markets, it is not yet clear whether it is willing to abandon this approach or push it over the barrier into full on policy action.

ECB stands firm but looks to wider measures

Over on his new Forbes blog, Open Europe’s Head of Economic Research Raoul Ruparel lays out his take on why the ECB decided to stand firm despite the apparent deflation threat,

“My feeling is that there are two broad reasons. The first being that the flow of data is mostly positive, and the second, more important factor, being that none of its tools are economically, politically or legally suited to tackling the low inflation environment in the eurozone.”

He concludes,

“All in all then, the tools at the ECB’s disposal are far from suited to helping push up inflation in the struggling countries and boosting lending to the real economy to help economic growth. This is not to say the ECB would never use them, but that are better suited to a deeper more acute crisis (such as a break-up threat) than the chronic long term malaise which the eurozone currently finds itself in.”

These are themes we’ve explored plenty of times on this blog so won’t rehash here.

But there were a couple of other interesting points to come out of ECB President Mario Draghi’s press conference though.

The first being his mention of a new dataset which the ECB is looking at, specifically the “the high degree of unutilised capacity” in the eurozone economy. This refers to the ‘output gap’, i.e. the amount by which GDP in the eurozone has fallen below potential GDP. As you might imagine, estimating such a gap is fraught with difficulty and estimates are notoriously revised retrospectively (for example before the crisis few economies were seen performing above potential despite huge financial, real estate and debt bubbles).

Why is this important? Well, it could be the first step towards a more firm GDP target on the part of the ECB. Admittedly, it’s a small step and a full GDP target is unlikely but it could be an interesting shift for the ECB which has traditionally focused more on inflation, money market and private sector survey data (such as the PMIs). As Draghi himself said, it also shows that monetary policy will stay looser for longer, even if the data improves, due to the large gap between actual and potential GDP. It will be interesting to watch how this one develops over the next few meetings and whether the ECB decides to put any more emphasis on this measure.

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.

Eurozone inflation hits its lowest levels for three years

Eurostat yesterday released its latest inflation statistics and the data for the eurozone provides some food for thought.

Inflation reached its lowest levels (1.1% on an annual basis) since February 2010. This might seem surprising on the surface given all the talk of a eurozone recovery and a turn around. Why hasn’t inflation followed? Well, generally inflation is a lagging indicator and therefore any recovery will take some time to feed through to prices and wages. However, as the graph below suggests, there is more at work here.

There has been significant disinflation (falling inflation but not negative inflation, which is deflation) in the eurozone and more importantly in the PIIGS. For all the talk of internal devaluation in the eurozone it has taken some time to feed through to the Consumer Price Index (CPI). Due to factors such as indirect tax increases and sticky prices and wages, it has taken some time for the impact to be fully felt – now that this is beginning to happen it is unlikely to stop immediately and could carry on for some time.

The data also shows that because of the effect described above, inflation in the PIIGS is diverging from the rest of the eurozone somewhat and particularly from the stronger countries in the north.

What does this mean for the ECB?

The FT has a couple of pieces today discussing this, calling on the ECB to do more to tackle the disinflation in the eurozone. While inflation is clearly well below the ECB’s target, the current nature of the inflation does present some issues for ECB policy.

• Firstly, there is the standard one size fits all conundrum – as inflation plummets in the PIIGS it remains stable in the north and threatens to increase as these countries post higher levels of growth. Adjusting the policies to suit these countries more could prompt unwanted outcomes in the stronger countries. Politically, it’s also worth remembers just how wary Germans are of inflation, as we highlighted recently. Finding the correct line between these two camps is incredibly tricky for the ECB.

• Secondly, while the struggling eurozone countries could use a boost in demand, the ECB may struggle to find the necessary targeted approach to do this. One measure which has been widely mooted is another long term refinancing operation (LTRO) to help boost liquidity in the market. However, as the graph above shows, there was no boost in inflation from the previous rounds, despite it totalling around €1 trillion. This is largely because the money did not filter through to the real economy and therefore did not impact consumer price inflation. Although things are improving there is still plenty of fragmentation in the market and loans to the real economy continue to fall in the PIIGS.

• This point also applies more generally in our view in terms of the tools at the ECB’s disposal. As we discussed at length here, although the ECB can do much to stop the break-up of the euro, it has fewer tools to help promote economic growth in the current circumstances, particularly in specific economies.

• In our view disinflation is not such a risk for many of these countries, in fact many need to see reductions in prices and wages to help boost their competitiveness, although it does of course have knock on impacts for their already flagging GDP growth. That said, deflation is a bigger risk because these countries have such large debt to GDP levels, which would only be exacerbated by deflation – although for countries such as Greece the need for further debt relief is already very apparent so the marginal impact of deflation is smaller.

All in all then, low inflation in the eurozone seems here to stay for some time due to the periphery pulling the average down, even if a fuller recovery eventually materialises. This will create some new issues for the ECB to deal with, however, given the divergence between countries it may well struggle to find the tools to have a big impact on this.

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.

A shift towards greater transparency at the ECB?

As we reported in today’s press summary, there has been an interesting development in the push for greater transparency at the ECB.

In a joint interview with Süddeutsche Zeitung and Le Figaro, Benoît Cœuré (BC) and Jörg Asmussen (JA), ECB Executive Board Members, both supported the longstanding call for the ECB to publish the minutes of the meetings of its Governing Council, saying:

BC: “Transparency is important for the effectiveness of monetary policy and for trust in the central bank. There was a time when the ECB was ahead of the curve in its communications and transparency as first central bank with regular press conferences by its president. Now the ECB is the only large central bank that does not publish its minutes of meetings. There is a demand in society for transparency and accountability. Therefore, I personally think that the ECB should start publishing its meeting minutes soon.”

JA: “The minutes should include who voted for what, and the reasoning behind that vote. Publishing the minutes will sharpen the European mandate, because the ECB will then have to explain why its decisions are in line with the European mandate.”

BC: “The other side of the coin is, as Jörg has said, that the Governing Council has a European mandate. The governors of the national central banks come here in a personal capacity – they do not represent their institutions or their countries – and should be accountable for what they do.”

This is something which many (including ourselves) have supported for some time (see here for a House of Lords report from 2003 which provides an interesting discussion of the issue), particularly during the crisis where the opacity of the ECB (on issues such as bond purchases, legal documents and potential policies) has at times caused confusion and uncertainty. It has also hampered the accountability of the ECB and its members despite the bank playing a central role in the crisis resolution.

But all that has been true for some time, so why might the ECB be changing its tune now? The most likely reason seems to be a switch in the communication policy of the ECB, which began last month with the change to ‘forward guidance’ (forecasting future interest rate policy). Although, this did little to change the substance of ECB policy (frankly everyone knew rates would be low for some time) it is a clear shift in tactics and rhetoric. Publishing minutes fits well with this new approach for a few reasons:

• It allows the ECB to provide further detail about its decisions and what the key motivating factors were.
• It highlights the discussions of various options which the ECB may be considering to combat the crisis, this could help telegraph future action and impact market sentiment without the need for an actual decision to be taken.
• It will demonstrate the weighting of support within the council for certain policy options, again providing further detail on likelihood of future actions but also the strength of feeling on various policies (i.e. a clearer picture of the dovish or hawkish nature of the council).
• Can be used to communicate concerns to the market and other policymakers which may not have warranted inclusion in the monthly press conference of the ECB President Mario Draghi. Furthermore, if published with a delay, can allow for reflection on the impact of different policies.
• Essentially, it provides a further tool in the arsenal of the ECB to help communicate with markets and achieve policy goals. As we have noted, the ECB has recently looked increasingly policy constrained and so any additional tool would likely be welcome.

All that said, the impact of this tool should not be overplayed. It is ultimately a small aspect of overall ECB policy, its main benefit is that it can provide further nuance to some of the blunter instruments (interest rates etc.). From an outside perspective it could provide a much needed insight into the decision making process – although this will ultimately depend on the credibility of the minutes (will they really reflect the true nature of the discussion) and when they are released.

On top of this, FAZ is reporting this afternoon that the ECB and national central banks will publish more details on the notoriously secretive Emergency Liquidity Assistance (ELA), although the article seems to suggest they may only release the framework or rules of ELA rather than details on its practical use and application. Still this would be a welcome, if small, step towards transparency.

Some steps towards greater transparency then, however, the underlying motivation seems more likely to be to give the ECB another tool in its new communication strategy rather than increasing accountability as an end in itself. Either way greater insight into the opaque institution playing a key role in the crisis should always be welcomed.

Doves dominate as central banks show the way ahead in Europe

While the US has its Independence Day, Europe looks to be having its Forward guidance day.

Bad puns aside, it’s actually been quite an interesting day in the world of central banking in Europe.

First we had the new Bank of England Governor Mark Carney surprising the markets somewhat suggesting that the increase in rates which had seemingly been priced in was premature. Essentially, providing forward guidance that the BoE would keep monetary policy loose.

More interesting for us though, was that the ECB took a similar despite not much being expected to come out of today’s meeting. Below are the key points from ECB President Mario Draghi’s press conference:

• “The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time.” This is essentially forward guidance (forecasting what policy will be in the future). It’s not full because there is no clear date set but still it is a big change from Draghi’s previous line of “we never pre-commit” (this has also been the line of the ECB generally since its inception). He also added at the end, “all in all we said our exit [from loose monetary policy] is very distant”.

• Draghi also stressed that the decision on this form of ‘forward guidance’ was unanimous (numerous times in the Q&A). Again surprising since the Bundesbank has previously warned against the problems of loose monetary policy, so one might expect Bundesbank President Jens Weidmann to be wary of committing to it for an extended period.

• When quizzed about whether the ECB was now simply reacting to the US Fed’s talk of tightening its monetary policy (the much maligned ‘taper’ which has sparked market volatility) Draghi insisted that the ECB takes its actions independently of those of any of the central bank. Behind the rhetoric though it seems fairly clear that the Fed’s policy has had an impact on European and global markets and the ECB felt the need to compensate for that. Draghi also said it was simply a “coincidence” that the BoE took a similar policy approach on the same day.

• As for the rest of the press conference, it was much as expected (more of the same). Draghi continued to stress the need for structural reform and for the creation of a clear banking union with a working resolution mechanism to recapitalise banks in the event that ECB find capital shortfalls when it does its asset quality review (stress test) next year. Draghi also distanced the ECB once again from action to boost lending to small and medium sized enterprises.

It seems all this caught markets somewhat unawares with stock markets rallying and both the pound and the euro weakening in response.

This suggests that central bankers may have a trick or two still up their sleeve, although the response is likely to be short lived. Ultimately, this is not a sea-change in the policy of the ECB, the fundamental challenges facing Europe remain.

This is getting personal: Handelsblatt likens ECB President Mario Draghi to the Little Corporal

Update 15:28:

Mystery solved. The good folks at Handelsblatt tell us that it's indeed Karl XIV Johan of Sweden (original H/T @Presseurop). Apparently, there's no particular reason for why they chose the Frenchman-cum-Swedish King, apart from seeking to depict Draghi as a 19th century sovereign.

Update 11:40AM:

People have pointed out to us that, in fact, it's not Napoleon Bonaparte that is depicted. Handelsblatt isn't exactly clear about who Mario Draghi has become on its front page, so we're left guessing. The two strongest contenders are Napoleon III – founder of the Latin Monetary Union (and who was defeated by the Prussians in 1870) and Karl XIV Johan of Sweden (who was one of Napoleon's generals but after being imported to Sweden to serve as a King, he eventually ended up fighting the French). The latter would imply a very high level of assumed knowledge. to say the least. We wonder what our readers think?

Today's frontpage of heayweight German daily Handelsblatt depicts ECB President Mario Draghi as Napolean, with the subtitle

"The toxic gift. How ECB President Mario Draghi is saving the euro while ruining savers".

 The article inside goes on to argue that: 

“as a result of the cheap money policies (…) new bubbles are emerging, insurers are suffering and savers threaten to lose their savings" 

It quotes former ECB chief economist Juergen Stark as saying 

“central banks must be the trusting anchor of the paper money regime. When they don’t do this and are being overburdened with all kinds of new tasks, this fragile system is under threat.”

The Napoleon reference probably has several different levels to it, but one thing is clear: it's not meant to be a compliment. Although German fears of inflation and lose money are well known this is getting personal.

The inbuilt political stand-off in the ECB's bond-buying programme

One of the many sub-stories of the Italian election is how it calls into question the ECB's bond-buying programme - the Outright Monetary Transactions (OMT). Not so much because of the ECB's ability to expand its balance sheet and stand behind Italy and Spain (though there's a clear cost to that). The reason is another one: unpredictable politics.

This is something we highlighted immediately following Mario Draghi's announcement to launch the OMT, in September 2012. We said:

"It will also be virtually impossible for the ECB to impose effective conditionality on debtor countries, meaning that the ECB can only hope that a series of unpredictable political decisions in member states will go in its favour."

To inject such conditionality, the OMT was linked to the European Stability Mechanism - the eurozone's permanent bailout fund - which comes with strict conditions (or at least is supposed to). To tap the OMT, a country has to be on an ESM programme. But, in effect, this made the OMT - despite it being run by an independent central bank - hostage to parliamentary and electoral politics.

As we argued in our analysis on the German Constitutional Court ruling on the ESM - a few days after the OMT announcement in September last year:

"...the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto."

Well, enter the Italian elections (and Beppe). Discussing the election results, we told the Telegraph on Monday that:

“People have forgotten that the OMT cannot be triggered without a vote in the German Bundestag. This is going to be a huge problem, and we may be back to the political stand-off between the North and South of Europe,”

And in our flash analysis yesterday, looking at the Italian election results, we noted:

“A fragmented, anti-austerity Italian parliament could also make it far more difficult for the country to tap the ECB’s OMT. This is because it would need to access the European Stability Mechanism simultaneously, meaning a series of strict conditions – which Berlusconi and others could resist – and approval from several Northern Eurozone parliaments, including from the Bundestag.”

Other analysts are now waking up to this issue as well.

Then again, if it ever came to a point where Italy actually needed to tap the OMT, things might be so bad that politicians on both sides (probably during a panic-stricken weekend) could be scared into accepting whatever ESM-deal that could be struck.

But it all goes to show that in the eurozone, there's no escaping the politics.

Draghi getting ahead of himself: are we really seeing a “normal situation” in eurozone financial markets?

In his monthly press conference on the 10 January 2013 ECB President Mario Draghi struck a relatively upbeat tone on eurozone, in particular arguing that the eurozone was returning to a “normal situation, from a financial viewpoint”. Don’t get ahead of yourself there, Mario.

True, he also warned against a slowdown in fiscal consolidation and structural reforms due to political complacency, but hinting that we’re now back to a normal finacial market situation seems particularly premature.

Firstly, to state the obvious, the ECB is still massively propping up the financial system in the eurozone. The ECB balance sheet stands at a massive €2.96 trillion up from around €1.5 trillion at the start of 2008. The ECB’s liquidity provision to banks across Europe has slowed in recent months but it remains exorbitantly high, to the point where many banks (particularly in struggling countries) are almost exclusively relying on the ECB for funding. In fact ECB exposure to the PIIGS totalled €1.08 trillion in November 2012. This is by no means normal (or at least shouldn't be).

There is also still significantly limited activity in the interbank lending market, with overnight volumes still near record lows (click graph to enlarge).

Data from the BIS also highlights that longer term bank lending and investment from stronger to weaker states continues to be dramatically below its peak (click to enlarge).

There are many other indicators, such as the limited lending to both businesses and households across the eurozone and the divergence in borrowing costs within different economies (for corporates as well as sovereigns).

Still, the situation in the Eurozone has clearly improved. Some factors, such as the capital outflow from southern to northern countries, have stabilised while others, such as the outflow of deposits from certain banking systems, have shown positive improvement. But we are still miles from being in what many would regard as a “normal situation”.

So when can we expect a “normal situation” to return? Well, with interbank channels having been absent for so long it is hard to expect a rapid turnaround. The ECB is also not expected to exit its massive liquidity provision anytime soon (and even when it does, it will likely be a gradual process), so this will continue to dictate the market. Plenty of other factors (economic growth, unemployment, social stability) also continue to fuel imbalances in the eurozone, so don’t expect cross-border lending or investment in struggling eurozone economies to return to pre-crisis level in the next few months or even years.

This is where the banking union is supposed to come in. However, as we have noted before, the current plans don’t a cross border backstop or a cross border resolution structure for failing banks, for example, so won’t really help in that respect.

Unfortunately, Draghi’s prematurely upbeat comments may have the perverse effect of encouraging the kind of political complacency which he warned about later on in his press conference.