What is the next move of the ECB? One thing is sure, they are getting prepared
In the last European Central Bank conference on 10th April, the central bank stated that the slowing down of economic growth is continuing also in 2019 and there are also various risk factors that could negatively affect the economy, like trade wars, weaknesses in emerging markets and declining business confidence.
Despite that statement, the ECB Chair, Mario Draghi, has been ambiguous about future measures, saying that there is a need for more information.
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In the last meeting, the plan was for a new cycle of long term loans in the form of TLTRO (Targeted Longer-Term Refinancing Operations) that was confirmed but we still have to wait for the details of those operations.
Overall the European Central Banks remains accommodative and really careful about the economic indicator.
Let’s see what they have to say about growth, inflation and interest rates.
EU Economic Growth is Slowing Down
European economic growth is slowing down, the last data available on the industrial production show a decrease of 0.9%, almost twice as expected Meanwhile Germany, the strongest economy, repeatedly showed signs of weakness that basically confirm worries about the economic future of the European Union.
In fact, it didn’t change in Q4 2018 and was near the recession territory without any sign of uptrend, this is why concerns about the economic crisis might be well-founded.
After a series of discouraging economic data, EU growth expectations have been revised downwards at 1.4% for 2019 compared to a previous 1.8% (november forecast).
In addition to that, many analysts think that they are too much optimistic and the reality could show even lower values at the end of the day.
In todays economy there are several risks of recession and first signs of weakness are starting to show up.
Despite the massive US debt, the risk of recession might actually be higher in Europe where the slowing down of the economy coupled with political tension creates a dangerous mix.
Risks like the threat of Brexit and the doubts about the deal, the Italian economy that is crushed by its public debt, political uncertainty in France and Italy, etc. If a real crisis hits EU, it could really represent a threat to the global economy.
Investor’s expectations about inflation are progressively going downwards and are at their lowest point since 3 years. The 5-years swap rate fell from 1.60% of December, towards the end of the QE to 1.36%, the lowest value since 2016.
The forecasts by the ECB also show that right now inflation is well below the target, at 1.4% for the current year and 1.5% for the next year.
In this context, many agree on the fact that a new wave of QE could be a possibility to foster inflation towards the 2% target
For now, it’s not clear whether there will be another QE if inflation should further decrease, the sooner the ECB gives information about its intention the better.
I think that when we are going to see a crisis in the near future (remember that there is always a crisis around the corner), QE is absolutely one of the weapons that the ECB will use to fight back the recession.
TLTRO and Interest Rates
Draghi’s reply about future movements had one clear point: the need for more information.
So we don’t have an exact idea of future movement in interest rates. What we know is that there will be a lot of attention on the transmission mechanism of the monetary policy.
In the next meetings, the details about the TLTRO will be discussed. In particular, the interest rate on those operations, that will take into account both the goals of the monetary policy and the economic growth perspectives.
Decisions about interest rates will be evaluated, taking into account the profitability of financial institutions in a negative interest rates scenario.
Banks in the eurozone currently pay 0.40% on reserves deposited at the European Central Bank. The positive implications of this policy for the economy and potential side effects need to be carefully weighted and new measures, like a tiered system, might be adopted.
Even if the ECB seems quite optimistic about the situation in the eurozone, it is preparing for a bear scenario.
Economic growth is a rising concern and recent economic data are not encouraging. We might see new interest rates cut if the situation deteriorates and expectations for the central bank intervention are gradually increasing.
Mario Draghi has made it clear that the ECB has all the tools needed to bring inflation back to the 2% target level. Given all the circumstances, and taking into account the FED shift in the monetary policy, the probability of a rates hike this year is really low.
In recent years monetary policy became one of the major drivers of the economy and interest rates act like gravity on every asset and economic variable.
Despite the negative economic data on economic growth, right now we are still in a relatively stable situation and we didn’t see any external shock or the beginning of a real crisis. In this scenario, we are already discussing interest rates cuts and a new Quantitative Easing in order to prevent the situation to further deteriorate.
In case of a real crisis, I wouldn’t be surprised to see a massive QE and you as an investor may decide to prepare accordingly.
My personal observation here is that QE is not a substitute for economic growth. Although an expansion of the monetary base coupled with easy credit is preconditions that are really helpful for an increase in economic growth, those are not the long-term drivers.
The long-term driver of economic growth is productivity, and it is something that is not controlled by central banks. Chances are that at the end of the day, we will find ourselves with zero growth and a huge debt burden to cope with.
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Originally published at moderntimesinvestors.com on April 16, 2019.
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