The ECB is committing a strategic error

Possible key-rate hikes have been postponed until far into the future. From my point of view, the ECB is committing an error by embarking on such a strategy. The ECB ought to seize the current opportunity to at least lift the deposit facility rates out of negative territory. The point is that negative deposit rates have the effect of a special tax on the European banking sector, worsening its position in the global competitive stakes. The simmering trade conflict could well decelerate growth momentum, thus causing a significant deterioration in the environment for possible key-rate hikes in Q4 2019. The ECB would then be confronted with a dilemma.

It emerges from the monetary-policy account published earlier today that Europe’s monetary custodians regard their promise to keep policy rates unchanged at least through the summer of 2019 as a good compromise – between providing the markets with sufficiently precise guidance about the path of monetary policy and maintaining adequate flexibility. At the same time, the central bank was at pains to prevent possible negative market developments in response to the envisaged termination of net asset purchases. Against this background, the ECB’s representatives have emphasised that monetary policy will continue to be very accommodative even after a termination of the net asset purchases under the APP. In particular, the Governing Council stresses that the intention to reinvest principal payments from maturing securities “for an extended period of time“ still implies a very significant presence in the bond market. Not least, they add, remaining uncertainties surrounding the inflation outlook call for a patient, prudent and persistently accommodative monetary-policy alignment. Overall, the ECB’s representatives showed confidence that prevailing market expectations fully reflect a winding-down of net asset purchases by the end of the year. The decision to terminate the APP was mainly prompted by expectations that the influence of bond purchases on the inflation rate was waning and that the European economy was strong enough to cope without the QE programme. At the same time, the ECB’s economists did go on record as saying that downside risks related to the simmering trade conflict were becoming increasingly prominent.

The ECB resolved at its most recent Governing Council meeting to prolong its asset purchase programme until the end of the year whilst reducing monthly purchase volumes. What surprised many market participants was the fact that the ECB went so far as to promise persistently low policy rates until the end of summer 2019. De facto, this means that the ECB has announced the timing of the interest-rate turnaround because the only dates to be selected from are presumably September, October (Draghi’s last interest-rate meeting) or December of next year. The only uncertainty concerning the future course of monetary policy relates to the bank’s policy over reinvestments. What is at issue here is less whether the ECB will abide by its reinvestment policy; it is more about the maturities it will be focusing on and about whether the ECB will only be reinvesting maturing securities in the same jurisdiction as principal redemptions. The ECB will probably provide further information about this in the coming months.


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