Eurozone: Industry-PMI flash estimates for January expected

ECB: If liquidity could solve problems, we would not have any!

European Court supports ECB

Eurozone: Industry-PMI flash estimates for January expected

ECB – If liquidity could solve problems, we would not have any!

Since the onset of the crisis, the ECB has used a variety of measures to support financial market stability and the real economy. In particular, financial market participants have watchfully observed every step of the central bank and have trusted and followed the words of M. Draghi.
Today, however, we must draw the conclusion that, while low interest rates and the supply of liquidity could offer stabilizing effects, it has not been sufficient to spur an economic recovery. Eurozone inflation declined into negative territory recently (-0.2% in December), mainly due to the fall in oil prices. The ECB would normally ‘look through’ external factors (the central bank cannot influence international developments or prices), but in this environment, second-round effects could occur. In an environment of weak economic growth, corporates might put cost advantages from lower oil prices through to maintain market shares. Such price competition would then depress core inflation, which has to be considered by the ECB.
Bearing these developments in mind, financial market participants found a consensus that the ECB is going to announce further monetary accommodation (sovereign purchasing program) at the next meeting on January 22. We expect the Governing Council to unanimously vote ‘yes’ on the question ‘Is further accommodation in monetary policy needed?’ However, in our view, the next question, ‘Which instruments should be used?’, will be the basis for an intense discussion. It was rumored that the ECB staff presented models for buying as much as EUR 500bn of investment grade assets to the policy makers. Also, it was said that smaller program sizes were considered along with monthly targets.
We assume that the ECB would have to buy at least EUR 500bn of assets to reach – together with other announced measures (ABS, covered bonds) – a balance sheet expansion towards EUR 3trn. Indeed, there is some potential for disappointment with regards to program size (too little or no indication of size) or regarding timing (no clear time-frame). Although sovereign bond purchases on secondary markets are possible according to Article 123 of the treaty (purchases on primary markets are forbidden), we think that the subsequently described opinion of the advocate general of the ECJ on the OMT is very interesting in this respect. He said that the timing of purchases should permit the formation of a market price. From this opinion, we can conclude that the ECB should not immediately start buying, but rather concentrate first on a precise announcement. If there is only a vague announcement without a time-frame for action, we could see some correction moves on the market.

Given the already very low yield level of Eurozone sovereign bonds, the effectiveness of a purchase program will be limited. Furthermore, some headwinds exist, as purchases to force yields down further could deliver wrong incentives to governments for necessary fiscal and economic reforms. Normally, yield increases (or high yields) are a strong sanction mechanism for politicians to introduce necessary steps. In the Eurozone, corporates need support for investments and structural reforms (e.g. more flexibility on labor markets, less bureaucracy, tax reforms, promotions for investments) to increase productivity in the mid term. Corporates need a perspective for the future to increase their investments. So, all governments should adapt their regional economic policies to support a competition-friendly environment.
Investments and technological progress are very important for long-term economic growth, in particular given the demographic development in the Eurozone. Higher growth in the future would ease the sovereign deleveraging process. If interest rates at zero and sufficient liquidity could solve our problems, we would not have any in the Eurozone.

European Court supports ECB

In 2013, the German Constitutional Court posed two questions to the Court of Justice of the EU (ECJ) regarding the evaluation of the OMT program (the purchase of government bonds by the ECB in the case of utilization of the European Stability Mechanism). The advocate general has now filed his opinion (which constitutes a proposal to the court) this week. In principle, the advocate general has supported the ECB with his opinion. As regards the first question, the advocate general has taken the view that the objectives of the program are in principle legitimate and constant with monetary policy and thus do not constitute an economic policy. As regards the second question which concerns the prohibition of monetary financing laid down in the Treaty on the Functioning of the European Union (short TEFU) the general advocate came to the conclusion that the OMT program is compatible, provided that the timing of its implementation is such as to permit the actual formation of a market price in respect of the government bonds. The judges of the court are now beginning their deliberations in this case. Judgment will be given at a later date (presumably in 3-6 months).

Eurozone – Industry-PMI flash estimates for January expected

Next week (January 23), flash estimates for industry PMI survey data for January will be published. The data will be important, since it is the first important point of reference regarding the industry in 1Q15. On average, industry sentiment in the Eurozone cooled down further in 4Q14 and points toward ongoing stagnation of industrial activity. In light of the current difficult situation, we do not expect a significant improvement of the sentiment in January.