Today’s press conference signals no change in the ECB’s stance, as the central bank scales back liquidity support at a barely perceptible pace, just enough to signal the direction of an excruciatingly slow normalization process. Overall, the ECB feels confident that a sustainable recovery is underway, both in Europe and in the global economy, but harbors no illusions as to its strength. The ECB is not losing sleep over the risk of a double-dip recession, but rather over the persistent fragility in the financial sector, underscored by the recent resurgence in market tensions. With inflation—and inflation expectations—well under control, liquidity will remain ample and rates low for quite a while. Trichet noted the uncertainty on the US outlook, acknowledging that this time around the ECB puts no faith in a possible decoupling. But it is decoupling within the eurozone which is becoming the thorn in the ECB’s side. Trichet resorted to his favorite comparison with the US to brush off concerns that the widening gap in growth rates across eurozone states might undermine the recovery or complicate ECB policy. I remained unconvinced: differences in national growth and unemployment rates pose a risk to national budgets and financial sectors that are potentially destabilizing—as confirmed by the recent resurgence in market tensions. Moreover, having witnessed bitter debates on fiscal austerity and export-led growth strategies, I shudder to think what will happen if strong growth should boost German inflation while the periphery still struggles with stagnation. And we should not forget that the one-size monetary policy contributed to boosting credit, debt and imbalances in the now embattled periphery. Diversity within such a large economy as the eurozone is indeed a fact of life, as Trichet noted, but it is also a problem that needs to be addressed more seriously.
The ECB announced today that it will maintain its exceptional liquidity support “for as long as necessary”, and at least into January 2011: the MROs and the special term refinancing operations with maturity of one maintenance period will continue as fixed rate tenders with full allotment (the fixed rate on the special term ones being the same as the prevailing MRO rate); moreover, the ECB will conduct 3-month LTROs in October, November and December, with full allotment, but the rate on these operations will now be set to the average rate of the MROs over the life of the respective LTROs. This as we know is a somewhat restrictive step, in that it implies that there is no cost advantage in borrowing at the 3-month LTRO rather than with successive recourse to the MROs. The 6-month and 12-month LTROs will not be renewed, as expected, and the ECB will conduct fine-tuning operations around their expiry dates.
Trichet emphasized that the decisions on liquidity operations are in no way meant to send a signal on the stance of monetary policy or the future direction of interest rates. He indicated that the liquidity decisions were taken by consensus rather than unanimity, but declined to elaborate on whether the dissenters had been arguing for more or for less liquidity support.
Today’s press conference signals no measurable change in the ECB’s stance: by allowing the 6 and 12-month LTROs to expire and moving the 3-month to a variable rate, the ECB can claim that it is gradually scaling back its exceptional liquidity support; at the same time, pledging that unlimited liquidity injections up to 3-months will continue for as long as necessary, the bank guarantees that it will not withdraw support at a faster pace than the market can withstand. Trichet indicated very explicitly that while financial market conditions are improving, tensions remain significant, uncertainty and volatility are still high, and the normalization process will take time. Overall, this points to a still very long period of ample liquidity.
Interest rates are likely to remain on hold for the foreseeable future, even if the ECB now sees risks to inflation as slightly to the upside. The staff forecasts for HICP inflation have been revised upwards a bit, to midpoints of 1.6% and 1.7% for 2010 and 2011 respectively. Trichet noted that risks to the new forecasts are slightly tilted to the upside: this is a slightly hawkish twist, but Trichet emphasized that upside risks are linked to commodity prices and indirect taxes, while domestic wage and price pressures are seen as moderate, and inflation expectations as well anchored. The change in the balance of risks to inflation is probably a nod to the hawks and underpins the ECB’s unconditional commitment to price stability, but it would be premature to see it as a harbinger of rate moves.
The ECB’s assessment of the recovery remains very pragmatic: Trichet expressed satisfaction that the eurozone’s recovery has been underway for over a year, with an exceptionally strong 2Q and encouraging data in the last few months, but stressed that he still expects momentum to weaken and growth to settle on a moderate pace. The new ECB staff growth projections, released today, have been revised upwards for both 2010 and 2011, to mid-points of 1.6% and 1.4% respectively, but Trichet underscored that this revision simply factors in the stronger than expected data of the last several months and does not indicate a more bullish view for the quarters ahead.
Trichet reiterated that the ECB is not declaring victory over the strong 2Q performance and is very well aware that the outlook remains uncertain; he said that risks to the new growth forecasts are seen as slightly tilted to the downside, with the negative risks stemming from renewed financial markets tensions and “some uncertainty about growth prospects in other advanced economies…”. The ECB recognizes that there is no room for decoupling, and that risks to US growth translate directly into risks to eurozone growth. Asked to comment on the US outlook, Trichet said he subscribed to the FOMC’s view, but added that one should not be too influenced by cyclical mood swings—my reading of this is that one should not be swayed by the current gloomy sentiment in US growth, which is colored by the high unemployment rate and therefore tends to overestimate the double-dip risks (but then again, that is my view as well).
Decoupling within the eurozone emerged as the thorn in the ECB’s side, as Trichet was asked whether the widening divergence in growth performance between core and periphery could undermine the recovery, and whether the ECB’s liquidity decisions were tailored to the needs of stressed banking systems in peripheral countries, at the risk of encouraging “liquidity addiction” in the eurozone’s banking system as a whole. Trichet indicated that the ECB recognizes the risk of liquidity addiction and is being extremely careful in fine-tuning its liquidity policy based on financial markets developments.
Trichet repeated his favorite argument, buttressed with new data: differences across eurozone countries are similar in magnitude to differences across US states, where over the last ten years the average GDP growth rate ranged from 0.9% in Iowa to 4.7% in Arizona, and the average unemployment rate ranged between 3.5% and 14%. The ECB is therefore in the same position as the Fed, making policy for a very large economy where regional differences are perfectly normal.
I remain unconvinced by the argument that a comparison with the US suffices to brush off cross-country differences within the eurozone.
The ECB announced today that it will maintain its exceptional liquidity support “for as long as necessary”, and at least into January 2011: the MROs and the special term refinancing operations with maturity of one maintenance period will continue as fixed rate tenders with full allotment (the fixed rate on the special term ones being the same as the prevailing MRO rate); moreover, the ECB will conduct 3-month LTROs in October, November and December, with full allotment, but the rate on these operations will now be set to the average rate of the MROs over the life of the respective LTROs. This as we know is a somewhat restrictive step, in that it implies that there is no cost advantage in borrowing at the 3-month LTRO rather than with successive recourse to the MROs. The 6-month and 12-month LTROs will not be renewed, as expected, and the ECB will conduct fine-tuning operations around their expiry dates.
Trichet emphasized that the decisions on liquidity operations are in no way meant to send a signal on the stance of monetary policy or the future direction of interest rates. He indicated that the liquidity decisions were taken by consensus rather than unanimity, but declined to elaborate on whether the dissenters had been arguing for more or for less liquidity support.
Today’s press conference signals no measurable change in the ECB’s stance: by allowing the 6 and 12-month LTROs to expire and moving the 3-month to a variable rate, the ECB can claim that it is gradually scaling back its exceptional liquidity support; at the same time, pledging that unlimited liquidity injections up to 3-months will continue for as long as necessary, the bank guarantees that it will not withdraw support at a faster pace than the market can withstand. Trichet indicated very explicitly that while financial market conditions are improving, tensions remain significant, uncertainty and volatility are still high, and the normalization process will take time. Overall, this points to a still very long period of ample liquidity.
Interest rates are likely to remain on hold for the foreseeable future, even if the ECB now sees risks to inflation as slightly to the upside. The staff forecasts for HICP inflation have been revised upwards a bit, to midpoints of 1.6% and 1.7% for 2010 and 2011 respectively. Trichet noted that risks to the new forecasts are slightly tilted to the upside: this is a slightly hawkish twist, but Trichet emphasized that upside risks are linked to commodity prices and indirect taxes, while domestic wage and price pressures are seen as moderate, and inflation expectations as well anchored. The change in the balance of risks to inflation is probably a nod to the hawks and underpins the ECB’s unconditional commitment to price stability, but it would be premature to see it as a harbinger of rate moves.
The ECB’s assessment of the recovery remains very pragmatic: Trichet expressed satisfaction that the eurozone’s recovery has been underway for over a year, with an exceptionally strong 2Q and encouraging data in the last few months, but stressed that he still expects momentum to weaken and growth to settle on a moderate pace. The new ECB staff growth projections, released today, have been revised upwards for both 2010 and 2011, to mid-points of 1.6% and 1.4% respectively, but Trichet underscored that this revision simply factors in the stronger than expected data of the last several months and does not indicate a more bullish view for the quarters ahead.
Trichet reiterated that the ECB is not declaring victory over the strong 2Q performance and is very well aware that the outlook remains uncertain; he said that risks to the new growth forecasts are seen as slightly tilted to the downside, with the negative risks stemming from renewed financial markets tensions and “some uncertainty about growth prospects in other advanced economies…”. The ECB recognizes that there is no room for decoupling, and that risks to US growth translate directly into risks to eurozone growth. Asked to comment on the US outlook, Trichet said he subscribed to the FOMC’s view, but added that one should not be too influenced by cyclical mood swings—my reading of this is that one should not be swayed by the current gloomy sentiment in US growth, which is colored by the high unemployment rate and therefore tends to overestimate the double-dip risks (but then again, that is my view as well).
Decoupling within the eurozone emerged as the thorn in the ECB’s side, as Trichet was asked whether the widening divergence in growth performance between core and periphery could undermine the recovery, and whether the ECB’s liquidity decisions were tailored to the needs of stressed banking systems in peripheral countries, at the risk of encouraging “liquidity addiction” in the eurozone’s banking system as a whole. Trichet indicated that the ECB recognizes the risk of liquidity addiction and is being extremely careful in fine-tuning its liquidity policy based on financial markets developments.
Trichet repeated his favorite argument, buttressed with new data: differences across eurozone countries are similar in magnitude to differences across US states, where over the last ten years the average GDP growth rate ranged from 0.9% in Iowa to 4.7% in Arizona, and the average unemployment rate ranged between 3.5% and 14%. The ECB is therefore in the same position as the Fed, making policy for a very large economy where regional differences are perfectly normal.
I remain unconvinced by the argument that a comparison with the US suffices to brush off cross-country differences within the eurozone.
- First, differences in GDP growth and unemployment have an impact on fiscal and banking sector developments at the national level, and these can be more destabilizing in the eurozone than in the US: weak growth in the periphery raises doubts on the sustainability of austerity programs, clouding the outlook for debt sustainability and financial sector stability; the same is not true in the US.
- Second, the eurozone lacks the labor mobility and the fiscal transfer mechanisms that cushion growth and employment differences in the US.
- Third and related point, the fact that borders within the eurozone are less porous, in an economic sense, than within the US, does have a dampening impact on growth as it limits the scope for efficient reallocation of labor and capital. Even in the US there is now a concern that the plunge in house prices may have dampened labor mobility (as households who owe more on their mortgage than their house is currently worth cannot sell it to move in search of better job prospects), contributing to a higher structural unemployment. Trichet implicitly acknowledged the importance of greater flexibility when he noted that the two eurozone countries where unemployment is now lower than before the crisis, Germany and Austria, are those where labor costs have been more contained.
- Fourth, differences in national economic performance in the eurozone can translate in a much more acrimonious policy debate than in the US: we have already seen bitter clashes on fiscal austerity and on Germany’s export-driven growth model; the next risk is that strong growth might boost inflation pressures in Germany while the periphery still struggles with recession or stagnation.
- Finally, we should remember that the “one-size” monetary policy has contributed to boosting credit, private sector indebtedness and macro imbalances in the periphery in the years preceding the crisis, with devastating consequences. Diversity within such a large economy as the eurozone is indeed a fact of life, but it is also a problem that needs to be addressed more seriously.
