Five takeaways from the ECB watchers conference:
1. The ECB makes not change to the baseline scenario.
- The recent slowdown is a “Soft patch” and not a “serious slump”.
- The loss of growth momentum could become more broad based “if external demand were to remain weak” and “if this were to spill over into domestic demand.”
- The weakness in world trade has continued on the back of trade disputes and a slowdown in China. Both extra and intra-euro trade slowed steeply last year. There are some signs that external demand may be affecting investment.
- The key question is whether domestic demand will remain as resilient today.
- The ECB keep their scenario of the sustained convergence of inflation to their 2% target. The ECB is still gambling on wage growth (negotiated wages growth!) translating into higher realized inflation. “The convergence of inflation to our aim has been delayed rather than derailed”.
2.The US is explicitly highlighted as a risk for the Eurozone economic outlook.
- “The slowdown in China and the waning effects of fiscal package in the United States” contribute to the increase in general uncertainty (Mario Draghi, 24 January) .
- Luis de Guindos added : “There is evidence that US monetary policy is a driver of a global financial cycle. In step with such a financial cycle the risks to euro area financial stability can change as well”.
3. The ECB sends is once again sending out strong signals for of lower rates for a longer period of time. In that this context, banks’ profitability are is under scrutiny. The ECB is studying options to offset the side-effects of its ultra-easy policy.
- There is no free lunch. “The perspective of low rates for longer has triggered the debate about the side effects of a negative rates” Praet said.
- “A financial sector not strong enough weakens the effect of the transmission” Jacob Frenkel outlined.
- Draghi said the ECB should if necessary “reflect on possible measures that can preserve the favorable implications of negative rates for the economy, while mitigating the side-effects, if any”.
- The ECB loan survey is in the loop!
4. ECB members try to reassure the markets that they are not running out of ammunitions.
- The last sentence of Mario Draghi’s speech : “We are not short of instruments to deliver on our mandate”.
- Key ECB interest rates remained the instrument for adjusting the monetary policy stance.
5. Debates on the new challenges that could emerge with regard to the independence of central banks and the risk management of their balance sheets.
- “Growth-friendly public finances based on sustainable fiscal plans and a sound composition of taxes and expenditures are essential for macroeconomic stabilization and lasting economic prosperity.”
- Huge debate around the independency of central bank in such unconventional times.
- Debate also on risks in Central Bank balance sheet (credit and duration).
The ECB is facing a slowdown without first normalizing its monetary policy. This conference has enhanced the idea that the low-interest-rate environment is the new normal. The ECB will now have to deal with the side-effects of its ultra-easy policy. A change in the baseline story (the convergence of inflation to the 2% target) would mark a turning point. However, we need to keep in mind that new unconventional measures could imply diverging interests between core and peripheral countries.