ECB: Draghi's Succession Matters

by: Alfonso Ricciardelli
Summary

With economic data worsening in the euro area, the ECB Board plans to prepare for a rate hike in September-October 2019 seem to have been shelved.

This makes the choice for President Mario Draghi's successor potentially more contentious, and interesting, as he would be the one likely setting the pace of tightening.

While current Board Member Benoît Cœuré and former Finnish National Bank President Erkki Liikanen are solid candidates in the race, the new name is OENB vice-chair Christian Ittner.

A Worsened Outlook

The 2018 Q4 eurozone economic data, published by Eurostat on January 31st, 2019, shows a generalized slowdown of economic activity throughout the currency area, mostly due to the negative trend in global trade. Uncertainty related to Brexit negotiations also had a sizeable impact.

Italy - now technically in a recession - has been the negative outlier but other eurozone countries didn’t fare much better - Germany, the European “engine,” also registered a contraction.

For the ECB, it was very bad news.

Frankfurt had been confident in its earlier projections, which forecasted only a minor slowdown in eurozone growth in 2019, with medium-term inflation expectations broadly intact, bolstered by wage increases - and rise in consumption - across the euro area.

While publicly the Central Bank's message had been one of caution, it was widely believed by investors that Draghi's pledge - the forward guidance - to keep rates unchanged "through summer 2019," was in fact pointing to a fall 2019 rate hike.

But current data, and the expectation of more uncertainty down the road - Brexit-related suspense until at least Q2 2019, the risk of a populist landslide in the upcoming EU elections, the unresolved US-China trade dispute - are likely to have an impact in the ECB's decision making process, and will most likely force the board to rule out any changes in the reference rates until later on in the year. Investors, as usual quick to read signals, have by now completely discounted any rate hikes until at least Q1 2020.

So, as it appears, President Mario Draghi is on course to end his ECB mandate without having raised rates a single time.

But most important, he is unlikely to be able to offer investors any valuable guidance on how the normalization process will be handled - this will indeed be his successor's task. And this is why investors should take a serious interest in the person who will inherit Draghi's job - as well as in his or her monetary policy views.

A Relatively Crowded Field

As it happens, Draghi’s succession can only be seen in the context of a larger reshuffling in European top jobs, a result of the upcoming end of the current European Parliament’s mandate (elections are taking place at the end of May). On that note, several Member states have already started pushing their top candidates for the most prominent EU jobs.

While the ECB Chief Economist position - now open as Belgian Peter Praet is also leaving the Board - we understand is a lock in for Irish Central Bank President Philip Lane, for the ECB Presidency there doesn’t seem to be a frontrunner just yet.

ECB staffers, EU institutions officials, and many members of the European Parliament have told us to be very partial to the “internal solution” - French ECB Board Member Benoît Cœuré.

One issue with his candidacy is that it is technically not allowed for a member of the Board to be lifted directly to the Presidency. In fact, the French Permanent Representation in Brussels quietly requested a legal opinion from the European Council legal services on the matter - a signal that Paris is seriously thinking about it - and it appears the rule could be skirted if Cœuré resigns early from his current post.

The Frenchman would be a safe pair of hands for investors, and would sure guarantee the legacy of Draghi’s interventionist approach. He might be a “bearish euro” outcome, though, as he is very much ingrained in the current ECB economic and policy thinking.

“Northern” Eurozone countries, the so-called “New Hanseatic League” that includes the Netherlands, Finland, and the Baltic States, have put their weight behind former Finnish Central Bank Chair Erkki Liikanen.

Liikanen is a moderate hawk, but not, by any stretch of the imagination, a Bundesbank monetarist the likes of Axel Weber or Ottmar Issing. He is likely to be less amenable to a prolonged period of ultra-low interest rates, but he is also a pragmatist who will not distance himself too much from the current ECB playbook.

His effect on the euro will most likely be neutral to slightly bullish, as he is, at least in theory, more inclined to focus on the upside of inflation targeting.

Interestingly enough, Berlin, who hasn't had a significant voice within the Board since former member Jörg Asmussen left in 2013, has not yet put forward any candidate for the job. And our understanding - but this should be taken with a grain of salt - is that Germany might in fact be preparing for a push to secure the Presidency of the European Council, whether for Chancellor Angela Merkel or another German top-tier policymaker it is hard to say at this point.

On that note, we have been told, the Permanent Representation in Brussels has been bolstered with more diplomats from Berlin, an increase in presence that has been noticeable, at least in the eyes of Brussels insiders.

If that was the case, it would be a signal that Merkel is not interested in the ECB top job, or that she doesn't have a good German candidate in mind for it.

But there is a twist.

In the past few days, we have been hearing Austrian Central Bank (OeNB) Vice-President Andreas Ittner has thrown his hat into the race for Draghi’s succession as well. Ittner seems to have the support of Merkel's allies, the Bavarian CSU.

And since the OeNB has been one of the most vocal sponsors of a deposit (alone) rate hike to assuage the country's banks - which have relentlessly lobbied current OeNB President Ewald Nowotny on the issue - it would be significant if an Austrian were indeed poised to take over Draghi's mantle.

As it happens, a deposit rate hike alone is considered by the ECB Board as a tightening monetary policy decision (the deposit rate is factually the "floor" of the eurozone rates corridor), and was therefore ruled out by Draghi when Nowotny first floated it in a public interview in March 2017. It even caused outrage as the President summoned the OeNB governor and criticised him for not staying on message.

This doesn’t mean Ittner could single-handedly decide for a deposit rate hike alone ahead of time, perhaps against the assessment of the Chief Economist and against data suggesting eurozone banks low profitability has little to do with negative deposit rates. But with some level of support by other countries where the banks are also rather unhappy (Germany is one of them), he might end up gathering enough support to eventually pass it.

This, in and on itself, would be a signal that the fundamental thinking within the ECB had changed, and that the Draghi days are officially over.

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