ECB: Everything can’t be bought – BBH

The European Central Bank (ECB) will continue with its extraordinary monetary policy and its balance sheet will expand by another 270 bln euros through the first three quarters, points out Marc Chandler, Global Head of Currency Strategy at BBH.

Key Quotes 

“We suspect the ECB will taper its 30 bln a month purchases in the fourth quarter rather than end them in September, though it is a close call. We expect a tame core rate to take the shine off any rise in the headline rate, likely driven by higher energy prices. Despite the broad and robust growth, core inflation in November 2017 stood at 0.9%. It bottomed in 2015 at 0.6%.”

“We are concerned that around the middle of next year, a factor outside the direct control of the ECB may cause the balance sheet to shrink. What we have in mind is that when the ECB is crafting its guidance for September, the banks will be able to pay back their borrowings under the targeted long-term repo operations (TLTROs).”

“Given the negative rates offered by the ECB and the short-end of the curve, ample liquidity, favorable deposit-to-loan ratios, and lukewarm demand for credit from households and non-financial businesses, we suspect some will opt to repay early. This would have the effect of reducing the central bank’s balance sheet. The return of a modest portion of the more than 700 bln euros borrowed under the facility could offset months of ECB purchases.”

“The ECB’s other measures, including the negative 40 bp deposit rate and the full allotment of refi operations at zero interest rate, will continue into 2019. The combination of the double dip cycle with the regional economy contracting in 2009 and then again in 2012 and 2013, and the arguably meek response by the ECB at the time, means that the ECB may have hardly begun to normalize interest rates and policy before the business cycle turns.”

“With the selection of Portugal’s Finance Minister Centeno to succeed Dijsselbloem as the president of the Eurogroup of EMU finance ministers, a two-year process has begun that will culminate with a new European Commission, ECB President, and European Parliamentary. The ECB board will change, beginning with the vice president toward the middle of 2018.”

“In negotiations to form a coalition government in Germany, the probusiness Free Democratic Party was demanding that countries be allowed to leave the EMU. Merkel’s position, like the ECB’s, is that monetary union is inviolable. The Social Democratic Party of Germany (SPD) may push in the opposite direction. At the SPD conference at the end of the year, the party leader (Schulz) called for a United States of Europe, which of course was immediately rejected by Merkel’s CDU.”

“The SPD will demand a high price to re-enter another coalition government with Merkel. Strategically, they need to be able to differentiate themselves. In addition to domestic social issues, the SPD can demand a ministry that ensures the international stage. They may be able to work with France’s Macron on the future of the European project after the financial crisis and Brexit. A shift of the political axis to the center-left will reinforce our expectation that Draghi’s successor at the ECB comes from a core creditor country, most likely Germany.”