A 'Robustified' ECB Cannot Create A Consensus On More Robust Easing

by: Adam Whitehead

Coeure and Lane give the ECB full marks for guidance, but insist that this must be followed up with commensurate action at the September Governing Council meeting.

Deteriorating external conditions are framed as the risk to the improving internal Eurozone economic conditions.

Germany Inc. is waiting for a “Germany First” fiscal stimulus before it mobilises private capital resources.

The current suggested fifty-billion EuroGerman fiscal stimulus is too low for Germany, the Eurozone and the global economy.

Consensus has not been achieved for the ECB to deliver what Mr Market expects in September.

(Source: European Parliament, caption by the Author)

Expectations of the ECB are way ahead of some of its Governing Council members. According to ECB Vice President Luis de Guindos, Mr Market needs to take a chill-pill and “Robustify”. The problem is that Mr Market has now seen Christine Lagarde’s self-declared KPI’s for her own performance appraisal reviews. It’s hard not to get carried away, when one has seen her intentions and capabilities. It is even harder to do so, when Mario Draghi is currently raising expectations as he passes the baton to her. Faced with all this pressure to go big, the Hawks are robustly resisting. The consensus-building process aka the “Robustifying” is not going to be smooth.

Heightened preparations by the ECB, for the next phase of monetary policy easing, were discussed in the previous report. “Rehnfeld” had already signalled that this will commence at the September Governing Council meeting. Recently, he reiterated that this next phase will be catalysed by the consistent failure to reach the medium-term inflation target. Almost simultaneously the latest Eurozone CPI data was released. Unsurprisingly, it showed another leg down, which fitted “Rehnfeld’s” medium-term inflation frame perfectly. Wasting no time, he then used the data, to frame perceptions and expectations for the upcoming Governing Council meeting, by opining that "the situation calls for an effective policy package in September." It was all looking fait accompli, until the Hawks interjected.

Recently released minutes of the last Governing Council gave greater perspective and context to the ECB’s preparations for the next monetary policy easing phase. The minutes showed that the ECB has a dilemma. Manufacturing is on or in recession yet the service sector, imports and consumption still remain healthy. Bank lending has also recovered and is moving on apace. Faced with this current incoming data, there is little justification for massive monetary policy easing. The case for easing needed some careful tweaking. This tweaking involved a careful balance of the imperative to ease, versus the risk that this would undermine confidence and occasion criticism from trade partners as an overt devaluation of the Euro.

The tweaking of the case for easing was driven primarily by Chief Economist Philip Lane and Executive Board member Benoit Coeure. Service sector and consumption strength was discounted by them, as a rational consequence of the consumers’ belief in future monetary policy easing. They thus gave themselves and their colleagues a massive pat on the back for their impactful guidance; and then averred that this guidance must be followed with action to sustain economic momentum and the ECB’s credibility.

Both men instructed the Governing Council to emphasise the deteriorating external conditions, visible in the Eurozone manufacturing data. Monetary policy should therefore respond to these signals external signals. Their advice also advocated an aggressive advertising, of the advanced monetary policy easing response, in the form of guidance. This aggressive advertising was then delivered by “Rehnfeld” in the first instance; in his framing of September as the start date for the next easing phase. All that remained therefore was action on said September start date.

With the start date identified, the ECB’s mission between now and then is to identify further economic evidence that builds the case for the easing. If and when the ECB moves in September, it needs as much economic data as possible to defend itself against President Trump’s accusations of unilateral currency weakening intent.

Governing Council member Madis Muller swiftly identified the latest CPI data as one such justification for the move in September.

(Source: the Author, caption inspired by Gladiator)

This series of reports has drawn attention to the unfolding gladiatorial contest in Italian politics and its implications for the Eurozone as a whole. The coalition government is now in its death throes, as Matteo Salvini prioritises his own political agenda over that of the nation and its wider Eurozone obligations. At this point, one should expect the invisible hands of foreign interests that are manipulating the domestic chess-pieces to become more visible.

The last report also examined the German national propensity to create surpluses, of the fiscal and trade balance kind, whilst simultaneously producing their reciprocal political deficits with trade partners. Germany is increasingly under the spotlight and microscope, as this propensity is dissected and examined by domestic and foreign commentators.

In his latest examination, German Finance Minister Olaf Scholz was maddeningly opaque and the annoyingly stingy. Initially all that he could give, by way of analysis, was a view that German interest rates will be low for a considerable period of time. This could mean that he thinks the ECB will ease again, or at least not normalise for a long period of time. Alternatively, he may mean that Germany will not borrow and spend; thereby driving the surpluses that keep German interest rates so low.

(Source: Bloomberg, caption by the Author)

Scholz used his picture as a call for Germany Inc. to invest and expand. As we know however, Germany Inc’s markets are contracting, therefore why would it invest. More likely, it will finance share buy-backs, with attractive low or even negative interest rates, to protect it from capture by global rivals. So far however, Eurozone Inc. including Germany Inc. shows no interest in borrowing to finance either capex or share buybacks. Germany Inc. in the form of the DIW, which speaks for the manufacturing sector, simply responds to calls to invest by declining to do so on the basis that it is expecting a recession in Q3.

The pessimism in the German industrial sector has already prompted suggestions of cutting the corporate tax rate to 25%. In the absence of fiscal stimulus to aggregate demand, such a supply side stimulus may still fail to garner the response desired from German companies however. This implies that further QE and even QQE will fail, unless accompanied by a massive fiscal stimulus.

In an attempt at clarity, Scholz then estimated the size of an alleged fiscal stimulus. He set this figure at fifty billion Euros, which seems a bit on the low side for Germany’s domestic economic situation. In Eurozone and global terms, where much less of this stimulus will trickle down to, the number is egregiously low. Just to show how small this figure is, it should be compared to the same figure thrown around by Matteo Salvini for the much smaller Italian economy. Once again, Germany has declined to take any kind of Eurozone or global lead, until its voters can be nudged in these directions. The nudge is currently under construction, with the appointment of a huge critic of the “Black Zero” fiscal policy as Scholz’s new deputy. It’s a move in right direction, but a painfully small one that is even more painfully slow.

German politicians can drag their feet on a massive deficit stimulus for some time, but public opinion will eventually demand that they borrow and spend; after the immigrants and feckless Southern Europeans have served their political purposes at the populist’s whipping posts.

The Keynesians will ultimately make their presence and doctrine readily available; and the politicians will frame it for and sell it to the German masses. The ECB can be relied upon to make the interest cost of said massive fiscal stimulus bearable for the German taxpayer. What is good for the Germans will then be viewed by some as good for the Eurozone in general; and other countries will try and follow the German lead. These followers will however find that, in so much as they have been the leaders in deficit financing, that their room to follow Germany is not as great as they had hoped.

The Bundesbank evidently wishes to get itself ahead of the politicians. This however does not bring it more closely into line with the ECB. The Buba is a studied measure of ambiguity, in comparison to the ECB. In its recently monthly commentary, the German central bank raised the probability of further slowing in the economy. The Buba did not however recommend a fiscal stimulus in response to the slowdown. Neither did it recommend further monetary policy easing. Neo-classically, the Buba expects low inflation to beget aggregate demand and then capex.

Buba President Jens Weidmann advises the people of the Eurozone, not to panic unduly and not to expect an interest rate cut. His advice is largely going unheeded. More interestingly, he has made it clear that he views the current two per cent inflation target as a ceiling and not a symmetrical objective. Any change from ceiling to symmetrical target should thus only be made after the ECB completes its monetary policy framework review with the new President installed. Weidmann is thus throwing a spanner in the works of further monetary policy easing, based on the current climate of disinflation, on the remainder of Draghi’s watch.

The reason for German policymaker timidity, on embracing the ECB’s drive towards further ZIRP/NIRP, became clear all too soon. German savers have reacted with a violent aversion towards NIRP. This has forced the finance ministry to hastily draft legislation to shield German depositors from the impacts of NIRP. The Bundesbank’s refusal to approve more ECB easing, even in the face of recession, reflects the violent German popular aversion to NIRP.

(Source and caption by the Author)

A previous report dubbed the policy makers’ response, to the current period of German introspection, as “Germany First”. This focused domestic political and economic response risks isolating Germany and its economy, from the rest of the Eurozone and the global economy. It was also noted that throughout history, similar periods of German introspection do not end well for Europe or the world in general.

(Source: Bloomberg, caption by the Author)

The problems in Germany should not be underestimated. They have implications for the Eurozone and beyond. Chancellor Merkel recently showed just how big the problem is. She also showed that it is taking on the contextual reference to periods of German introspection past. “Germany First” is in fact an attempt at holding together the two halves of the country that were ostensibly united when the Berlin Wall came down.

The German East has not participated in the benefits, of globalisation and the Eurozone, to the same degree as the West. The East has been a recipient of wealth transfer from the West by way of compensation for the lack of said participation. Clearly a “Black Zero” fiscal policy will choke off this wealth transfer. Germany thus faces a new political split, by nature of its own fiscal policy. This should also be viewed as a cautionary tale, for the unity of the Eurozone, if Germany does not change its fiscal outlook therein too.

(Source: Bloomberg, caption by the Author)

“Germany First” is now challenged to become “East Germany First”. The Eurozone is way down the list of German priorities. Poland is even further down the list than the Eurozone. In a poignant reminder, of previous periods of German introspection followed by periods of “Germany First”, the Poles resubmitted their invoice for war reparations on the eightieth anniversary of the Second World War. They received a “Black Zero” eighty-year-old overdue receivable, wrapped in a contrite German apology. Germany lacks the fiscal means to pay war reparations. It also lacks the political will, when the payment of reparations would be seized upon as political capital for the German populists.

The need to deflect economic resources to the East, also directly vitiates against German fiscal commitments to the Eurozone. Unless Germany abandons “Black Zero, at the national and European level, there is a real risk that it will be in economic and political conflict with the Eurozone in the very near future. There are small signals that Germany is changing its stance. Merkel’s SPD coalition partners have recently intimated that they would like the government to borrow and spend.

This fiscal stimulus will only be focused on the Germany economy, but it may trickle down to the Eurozone in general. More importantly, it demonstrates an emerging German willingness to approve fiscal expansion. Other Eurozone nations will try and leverage over this change in German sentiment. The problem for them is that Germany is starting off from a balanced budget position, whereas they are already in fiscal deficit. There is still no hint from Germany that it will approve Stability Pact rule bending, to expand deficit financing in its neighbours. There is also no chance that it will approve fiscal burden sharing with its neighbours, given the strong populist push-back against this from within Germany.

The chaos in Germany and Italy frames perceptions of the anticipated next move by the ECB. In light of this fact, Governing Council member Peter Kazimir emphasised that, whilst personally he is leaning towards easing at the next meeting, it is critical that the ECB is perceived to have a credible consensus before it embarks on its next policy move.

This consensus could be difficult to attain in the case of Germany, although its ugly economic data is helping to nudge the Germans into line. Notwithstanding the weak German data, it is unlikely that this consensus will be achieved by the next Governing Council meeting. It is thus likely that Draghi may have to use the meeting and his cleverly worded press conference, to signal that a consensus will be reached by the time Lagarde takes the helm.

ECB Vice President Luis de Guindos has an affectionate word to describe the kind of consensus that Draghi is creating for Lagarde to inherit. He calls it “Robustifying”. In his words, this means the ECB not being led by Mr Market’s view of the data but by its own view. Mr Market has got so carried away, that he is way ahead of what the Germans will accept. He therefore has to be guided and harnessed, to discount the future so that price discovery by Germany is plausible and acceptable.

In de Guindos’s robustified guidance, the ECB is going to act “not ... aggressively but with a lot of determination”. This means that the ECB will underwhelm Mr Market’s current expectations in terms of the initial size of the next easing. It also means that the ECB will overwhelm in terms of the duration over which this sustained incremental easing lasts.

The ECB Hawks are anything but robustified at the moment. In fact, they are robustly warning Draghi that they will not support a further easing decision at the next Governing Council meeting. In addition to push-back from Weidmann, Draghi has to contend with resistance from Klaas Knot and Sabine Lautenschlaeger.

Outgoing Governing Council member Ewald Nowotny’s parting shot, was to warn that monetary policy needs a little tweaking rather than a massive new stimulus. Qualitative Easing, through equity purchases, is totally out of the question in his view.

The split within the Governing Council appears to be forming along the traditional North-South fault-line. Nowotny’s replacement Robert Holzmann has already intimated that he is against further easing. This compares with Spain’s Pablo Hernandez de Cos, who recently argued that it should not be ruled out prematurely.

In fairness to the Hawks, they are simply voicing a commitment to the current already communicated intention and capability to apply a new round of TLTRO stimulus. This commitment has been lost in the drama of trade wars and weakening Eurozone economic data. They would just like to follow through on it first, before embarking on a new radical expansion of monetary policy. Their only aversion to a radical expansion, is that the TLTRO has no been fully applied yet; neither has time been given for its impact to work through the Eurozone financial system. As Lautenschlaeger said, it is too early for a “huge package”. She is not averse to smaller ones though. Draghi is currently embarking on a new phase of monetary policy easing, even before the latest TLTRO has been applied. This is the kind of panicky behaviour that Weidmann cautions against.

(Source: European Parliament, caption by the Author)

The Hawks may also have been totally shocked by what they have now seen as Christine Lagarde’s intentions and capabilities. The appointment of Lagarde initially met with cynicism from the European economic elite. She was viewed as a political appointment at best, who would act in the political interest of the entrenched Eureaucracy; and as a token female appointment at worst, by European misogynist elite. It was therefore highly important that her appointment process evinced no signs of nepotism, tokenism and/or watered-down standards. Best governance practice of the highest unimpeachable standard was thus imperative.

The European Parliament’s Committee on Economic and Monetary Affairs, was tasked as custodian of best practice and high standards. In an unprecedented act of transparency, the committee issued a draft report which outlined the whole appointment process for Lagarde; ranging from her CV to interview questions on macroeconomics, monetary policy and financial stability policy.

Lagarde’s CV is lengthy and impressive. Her knowledge of macroeconomics, monetary policy and financial stability policy is equally impressive. Whilst evincing a belief, that there is room for further monetary policy easing, she makes all the right noises about balancing the macro-stability risk created with buffers and tighter capital adequacy regulations. It is therefore impossible to find any fault in her ability and qualifications, despite the fact that she does not come from the elite ranks of the Eurozone central banking fraternity.

What has frightened the Hawks, is that Lagarde’s undoubted ability massively underpins some intentions and capabilities that came out in the Q&A process. Lagarde considers the risks, to the banking system from NIRP, as negligible in comparison to the volume of credit creation, consumption and investment that it has created in the Eurozone. Putting two and two together, the current global economic weakness combined with her conviction on NIRP, makes a new round of unconventional monetary policy easing an academic certainty on her watch.

Since the Eurozone manufacturing economy has fallen off a cliff this year, Lagarde’s implied unconventional monetary policy stimulus will therefore be massive. The TLTRO stimulus is chump-change, compared to what is coming after. Considering that the benchmark interest rate floor is -0.40%, it is no wonder that the Hawks are worried. If this is not enough, then the fact that the Bundesbank has recently announced that it is quite open to the prospect of negative mortgage interest rates may have tipped the Hawks over the edge.

“Robustifying” is a new word for Mr Market. The combination of this new word and less than anticipated delivery, at the next Governing Council meeting, will not sit well with him. Yet still, the dulcet tones of a Draghi press conference and anticipation of Lagarde in October should be enough to keep him buying into the easing story.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.