Five brief (discussion) points about today’s measures

(1) By signalling a shift of policy focus towards unconventional measures and away from rates, Draghi has forward traded his view on relative importance of currency depreciation (“FX channel”) versus growth of domestic credit (“bank lending channel”) in the recovery of the Eurozone.

Of course the two channels have been working effectively together to date (bank lending volumes are growing and the trade-weighted EUR is down), but this is a decisive shift.

It’s a risky strategy: there is plenty of evidence that it is structural factors and clogged up balance sheets that are the main impediments to bank lending [and investment grow]—both to SMEs and larger corporates—as opposed to the availability of sufficiently cheap liquidity or bank profitability concerns. All the while Benoit Coeure recently laid out that while exporting slack is obviously not a desirable long term strategy, at least it’s effective until the Eurozone gets round to fixing its imbalances.

How? TLTRO II: €1,25tn of not only cheap, but negatively priced (provided you increase your balance sheet in the right way) liquidity available to banks on a four year maturity. His Q&A rhetoric aimed to address bank profitability concerns square on, from guiding away from further rate cuts (“…we don’t anticipate that it will be necessary to reduce rates further”) to the strange Pillar 2 MDA addendum at the end.

Why? It’s unlikely that the recent G20 in Shanghai has heralded in an end to global currency wars, despite what Draghi said (“..in the G20 in Shanghai all countries took a solemn agreement that basically they would avoid such war”). First, the market’s decisively unfavourable reaction to BoJ‘s policy package. Second, the Fed’s tightening posture looks considerably more favourable [from a EURUSD perspective] now than it was in January. Third, it is probably a trade that Weidmann (representing ze Sparkassen) et al. can agree with. Finally—and most optimistically—perhaps Draghi is genuinely optimistic about the outlook for structural reforms in the Eurozone, for reasons unbeknown to us yet.

All said, not that weren’t looking already, but the miniatures of Eurozone bank lending data will become a critical tool for evaluating the success of this policy pivot in the latter half of the year.

(2) The ECB’s staff forecast for HICP over 2018 [implicit definition of the “medium-term” (?)] is only 1.6%. The convention of previous staff forecasts has been to include the impact of the co-announced policy measures in the staff forecasts. This would have led to an odd and unprecedented situation today: the ECB would have announced a new stimulus package which it concedes is insufficient to reach “below, but close to, 2% [HICP] over the medium term”.

Turns out the previous convention is not applicable for this forecast, probably because the technical details of the two flagship policies (TLTRO II & CSPP) are not yet known, even by the ECB themselves [“on the hoof”].

(3) It’s interesting that Draghi referred to helicopter money as “a very interesting concept being discussed by academic economists” which the ECB has not yet studied. Senior ECB staff have previously dismissed it outright.

It’s well known that Draghi is working frantically behind the scenes at the European Commission to try and push for more favourable fiscal conditions. Perhaps helicopter money is the backup plan if both the policy pivot [see (1)] and his fiscal diplomacy both fail.

(4) CBPP3 has completely distorted the covered bond market: from draining liquidity and price discovery in the secondary market to squeezing allocations in primary. Little wonder investment grade corporate investors are so apprehensive. [Purchases will not start until the end of next quarter, so get your chunky orders in to syndication desks quickly.] As with the inclusion of regional bonds into PSPP announced in December, no technical details are avaliable yet.

The good news is that with the deposit rate having been cut and Bund yields climbing, it’s unclear as to what extent it will be required as a substitute asset for hitting the new €80/month target.

(5) In a piece in January I asked (in a hypothetical question to Mario Draghi):

In September you shrugged off a Parliamentary question about the eventual exit strategic from APP as a “high-class problem”. But now that the Governing Council have guided on principal reinvestment at the end of the programme, this seems unfair. Indeed, a week after you dismissed the question, Peter Praet said: “For one thing, rate increases will have to be carefully aligned with the normalisation of central bank balance sheets. There will be some division of tasks between instruments to be thought through and organised: what portion of accommodation can be removed — quite conventionally — by raising short-term rates, and what portion by active management of portfolios, i.e. by applying controlled pressure on long-term rates. The profile and evolution of short-term rates and the shape of the term structure will probably look different than in previous normalisation cycles.” The Bank of England recently guided it will only start unwinding its QE asset purchases from its balance sheet when rates hit 2% — is it likely the ECB will use the same strategy? Will the reinvestment policy be undertaken without prejudice of how the APP is phased out? If so, does that mean that the ECB could continue to buy, at a slower pace, on top of reinvestments of maturing bonds?

Interestingly, this statement goes some way to answering that question:

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Correction, 11th March: TLTRO II: €1,25tn, not bn, obviously.