On Praet/Mersch yesterday, ECB conundrum

In an interview with Handelsblatt published yesterday evening, Peter Praet, the ECB’s chief economist, said the ECB would have pared back market expectations of the December 3rd announcement were it not for the “quiet period” (the seven days before a Governing Council meeting in which Executive Board members do not typically publically comment on monetary policy). This does not make sense for two reasons.

First, the two pieces of communication that framed market expectations most significantly in the weeks running up to the Governing Council meeting (inferred by the Eonia curve) were Peter Praet’s own speech, on November 19th, and Mario Draghi’s “what we must” speech the following day at the European Banking Congress. If either felt the market had greatly overreacted or misinterpreted they had plenty of time before the quiet period began to clarify—but Draghi and his close allies on the Executive Board chose not to.

Second, the ECB have often used leaks via “sources” (“said to”) as a tool to shape market expectations, especially during the quiet period. While the pre-Governing Council meeting dinner was in full swing:

In retrospect this could be interpreted as an attempt to dial back expectations at the very last minute.

Mersch

Not all of the Executive Board agree. Yesterday morning Yves Mersch attributed “positions being built up” principally to leaks (not the type the ECB use as a communication tool—the type journalists dig up) from Eurosystem committees.

Indeed, in addition to the two aforementioned speeches, the Reuters “two-tier deposit story” story of November 25th was the third main driver of high market expectations (or “flights of fancy” as Mersch so affectionately called them) in the run up to the Governing Council meeting. Mersch said yesterday the measure never had any chance of approval. If that was the case, and the Executive Board felt that market expectations had become (dangerously) exaggerated, why did one of the Executive Board not move to clarify—explicitly or implicitly? There was still a day left before the quiet period began.

Contrary to what Peter Praet said yesterday, market expectations were already at their peak going into the quiet period: there were no further significant amplifications during the period. That the flash reading of Eurozone core HICP undershot consensus expectation on December 2nd only served to consolidate high expectations.

What does this mean?

My own feeling—contrary to consensus opinion—is that Draghi didn’t misjudge his ability to push a given package (backed by the evidence) through the Governing Council—an exercise of diplomatic calculus of which Draghi is a master—but he misjudged the evidence itself. Of course the “evidence” was the analysis, and recommendations, of the Eurosystem committee led review which Draghi kicked off in October.

Draghi, in my opinion, over-estimated how much leverage the aggravated committee analysis and recommendations would give him for his preferred, more aggressive package—the one he was guiding markets on all along. But the review actually said: you don’t need to do that much. This fatal pre-judgement only became clear very late in the day, perhaps on the eve of the Governing Council meeting. Of course this would explain why there was no paring of market expectations before or during the quiet period.

Perhaps Draghi could have secured his preferred, more aggressive package (holding the misjudged evidence that pointed to doing less) in a Governing Council vote but chose not to: he concluded the risk-to-reward ratio wasn’t worth it. A large majority was important, losing the vote would be a disaster.

A concern

What all ECB communication has been clear on since December 3rd is that there was a “very large majority” for the package of measures proposed by Draghi and his Executive Board. This was central in Draghi’s speech to the Economic Club of New York on December 4th.

“There was also very broad agreement with the extent of the recalibration, which was based on technical work carried out by the staff of the whole Eurosystem in our committees.”

My reading of the over-arching aim of the speech was to try and re-frame the ECB monetary policy making process, at major junctures, as one led by technocratic Eurosystem committees. What they propose, at the least, will always be accepted by the Governing Council by a large majority. This worked to quash market concern of a resurgent spirit of the hawk that could succeed in derailing any further expansionary measures, even if judged to be needed by the evidence.

But a sting in the tail came the day in a Reuters story the day after:

“Opponents worked to curtail proposals coming out of the ECB’s committees that prepared the decisions, ensuring that some of the more radical measures expected by market players never made it onto the table.”

If the technocratic Eurosystem committees which Draghi has put at the front of this strategy are seen to be riddled with politics, it clearly both undermines this strategy and damages ECB credibility.

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Correction, 13th December: Yves Mersch did not say market expectations were “absurd” and caused by a “massive failing of market analysts”, Governing Council member Ewald Nowotny said this the day prior. Yves Mersch actually spoke of “positions being built up”.