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Frankfurt Expectations were high and they have been disappointed, at least in part: Christine Lagarde, president of the European Central Bank (ECB), did not promise any further easing of monetary policy on Thursday.
He repeatedly emphasized that the relatively high euro exchange rate played an indirect role in monetary policy because it had an impact on prices. The Governing Council has debated it “extensively”, he stressed after the meeting of the body made up of directors of the ECB and presidents of the national central banks of the euro zone. But what many observers were missing was a concrete indication that the ECB might actually take countermeasures. The European common currency has appreciated about six percent against the US dollar since the beginning of June.
Still, he has not made any new decisions, which was predictable. But many economists and investors would have expected at least some hint of future decisions. Katharina Utermöhl, European economist at Allianz, outlined a possible scenario beforehand with “speeches in September, action in December.”
Lagarde also commented relatively relaxed on currently very low inflation in the euro area. Prices have fallen slightly recently and the ECB does not expect a bullish turn until next year. For the year as a whole, the central bank’s inflation forecast is 0.3 percent with an economy that contracts 8.0 percent, for 2021 then 1.0 inflation with 5.0 percent growth and for 2022 1.3 percent inflation with 1, 3 percent growth.
Lagarde stressed that he saw no danger of falling into deflation. The recently very weak figures are due, among other things, to the VAT cap in Germany.
All in all, Lagarde markets had apparently expected an even softer line: In any case, the euro rose against the dollar for a short period of time during the afternoon press conference at $ 1.19.
Robin Brooks, chief economist at the major IIF banking organization in Washington, commented: “The biggest risk at the press conference was that low inflation would be downplayed and everything would get stuck in the euro. Unfortunately, it appears to be the same. ”
Frederic Ducrozet of Swiss bank Pictet even wrote on Twitter of Lagarde’s laid-back description of very low inflation: “You can’t be serious, that was a surprise even to inflation experts, and the short-term outlook is dire. “. He cautioned that it was too late to respond: “The history of the ECB is full of bouts of hesitation, which then only led to even more being done.”
Jörg Krämer, Commerzbank’s chief economist, expressed a completely different view: “At today’s press conference, ECB President Lagarde reacted politically correctly to the strength of the euro and did not announce any countermeasures. But make no mistake. At the turn of the year, the ECB should ease its monetary policy even more, and even more so if the euro appreciates even more. ”
Ulrike Karstens, European economist at fund company DWS, said: “What is new is the inclusion of the exchange rate in the initial statement, which is a clear signal of the concerns of the Central Bank Council.”
Lagarde himself had pointed out that the course was not mentioned above. Citigroup economist Ebrahim Rahbari believes the ECB will only react significantly to the exchange rate if the euro continues to rise, for example, by another five percent.
The exchange rate issue is sensitive, mainly because the exchange rate has not traditionally been allowed to be a target for the central bank. Monetary politicians are in charge of interest rates, governments are in charge of the currency, that is the rule, which, however, no longer works so well with free exchange rates. Central bankers are also cautious on the issue because they don’t want to be accused of deliberately depressing their own currency to help domestic companies.
On the other hand, the course is an important factor for all economic events. Also, no one likes to talk about this either, it plays an important, sometimes even leading role in implementing monetary policy goals: a soft currency leads to higher import prices and can boost the economy; both together should lead to inflation rising a bit, and then again approaching the desired target of two percent.
The ECB’s expectations were so high because the United States Federal Reserve (Fed) had previously announced a new strategy that would result in softer monetary policy. Immediately afterwards, the question arose whether the ECB would do the same with similar announcements.
Going forward, the Fed wants to tolerate exceeding its inflation target by two percent, only targeting an “average inflation rate” of two percent over a longer period of time. That means “higher and higher equity valuations, low risk premiums on interest-bearing securities and a weaker dollar,” wrote Andreas Steno Larsen, chief strategist at Nordea Bank.
The strategy could be adjusted
Lagarde has confirmed that measuring inflation and defining the inflation target will be important points in the debate on the ECB’s strategy, which is just starting this month, postponed by the corona pandemic. But he was reluctant to address the possible outcomes beforehand.
Allianz economist Utermöhl suspects that the ECB “probably also points out in its own debate that it would also tolerate a temporary overshoot in inflation.” However, not just targeting an average inflation rate as the Fed does. But, as other economists also hope, it will likely define two percent explicitly as a “symmetric target” after it has officially targeted “near inflation.” , but less than “two percent.
However, the ECB has been emphasizing since last year that its inflation target is symmetric. This has already meant that too low inflation is fought in the same way as too high inflation. Lagarde also brought up other topics in the strategy debate, such as digitization, including a possible digital euro, climate change, and communication.
Because the ECB has not passed any new resolution, the official official rate remains at zero and the practically most important deposit rate at minus 0.5 percent. The ECB will continue to buy € 20 billion interest-bearing paper per month at least until the end of the year, and can also use an additional € 120 billion on a flexible basis as part of this monetary policy program. The emergency program created specifically for the pandemic will maintain its previous volume of 1.35 billion euros, which can be used to purchase bonds as needed.
Some economists, like Elga Bartsch of the Blackrock fund company, had called for an expansion of another $ 500 billion in advance. Lagarde made it clear that he expects full use of the previous volume, but no expansion was discussed. The program was increased by 600 billion in June. As the situation in financial markets relaxed, the buy program has been used a little less recently.
A question of credibility
So far, only € 500 billion of volume has been used up. So the central bank still has a lot of room for maneuver. In August, it purchased additional bonds through the program for just € 60 billion net. However, purchases tend to be a bit lower in the summer months, due to less liquidity in the markets.
More recently, Isabel Schnabel, a member of the Executive Board of the ECB, said in an interview that she currently considers the volume of the program to be “appropriate” and that the ECB has reduced the volume of weekly purchases somewhat due to the more relaxed situation of the financial markets.
Lagarde praised this emergency program known as PEPP several times. It is very effective, it has kept the risk premiums of the public debt of countries with weaker finances within the framework and has thus countered a possible “fragmentation” of the euro zone.
Plus: Handelsblatt Today Podcast: The ECB is the Fire Department in the Crown Crisis.
