ECB discretionary or on autopilot? – Commerzbank

Once again, there is disagreement among the members of the ECB Governing Council about what the monetary policy reaction function of the European Central Bank should look like. In the one hand, Mario Centeno, head of the Banco de Portugal, argued in favor of lowering the ECB deposit rate to 2% on autopilot. Yannis Stournaras, governor of the Bank of Greece, recently sounded a similar note. On the other hand, ECB chief economist Philip Lane and Bundesbank chief Joachim Nagel argue in favor of a cautious, discretionary approach, Commerzbank’s Head of FX Research Ulrich Leuchtmann notes.

The upcoming ECB approach means everything

“The latter may also end up with a deposit rate of 2%, too. Nevertheless, in my opinion, both approaches have different consequences for the EUR exchange rates. Please note that the valuation of a currency in the foreign exchange market is not primarily determined by expected returns (the ‘carry’). The differences in these are negligible compared to what can be gained or lost from exchange rate fluctuations.”

“Now, a monetary policy that changes the key interest rate on autopilot runs the risk of missing out on new developments. If you have switched on autopilot, you tend to miss out on new situations. In particular, because the ECB was the very last G10 central bank to react to the post-corona inflation shock, it has the stigma of sometimes missing crucial developments.

“I think the market would not appreciate an ECB monetary policy on autopilot at all and would respond with visible EUR weakness. In the near future (including the next ECB press conference on December 12), I will therefore pay particular attention to which of the two camps will gain the upper hand.”