Opinion

James Saft

ECB calls in the consultants. Hurrah?: James Saft

August 7, 2014

Aug 7 (Reuters) – Relax, people, the ECB is going to hire a
consultant.

You might think that the threat of deflation, a recession in
Italy and some alarming signs of slowing growth in key member
states like Germany would call for action from the euro zone
central bank.

But this is Europe, and it’s August, so instead, apparently,
we are waiting for the finishing touches to be put on a contract
for someone to advise the ECB about reforming the asset-backed
securities market so it can stand to buy the bonds.

“The other news is that we are about to hire … a
consultant to help us design this program in the best possible
fashion,” ECB President Mario Draghi told the press conference
after the ECB left rates on hold and announced no new meaningful
initiatives.

It is not known if this consultant is one person or several,
nor if he or she possesses a magic loom that can spin straw into
gold.

We do know that, while the old, bad ABS market was fatally
flawed and fixing it will be complex, we’ve been discussing its
potential resurrection as a fulcrum for monetary policy for some
time now. So forgive me if I find the idea that the ECB is
“about” to engage a “consultant” who will “help” less than
compelling. It’s all very prospective, out in the future, and
were I a small business person in Belgium suffering from the
lack of credit due to the woeful state of the euro zone banking
system, I might possibly be a bit impatient.

And yes, the ECB brought a lot of questionable collateral
into its ambit in the aftermath of the financial crisis when it
was, in essence, the ABS market and deals were tailored with one
perhaps not so discriminating client in mind.

So, the issues are complex, to be sure, but Draghi and the
ECB seem happy to sit back and let the steps they took in June -
a negative deposit rate, targeted long-term refinancings and a
cut to the refi rate – take effect. This passivity also has the
potentially salutary effect of ratcheting up pressure on member
states to speed reforms, something Draghi all but pointed out by
noting the large variation in the quality of the so-called
recovery across countries.

TACTICS OR STRATEGY?

That strikes me as a policy that may amount to good tactics
- sit, gather information, increase pressure on other
stakeholders – but bad strategy.

The evidence seems clear that performance in the euro zone
requires greater steps, but Draghi’s testimony seemed too
relaxed and lacked urgency.

“The degree of obfuscation and prevarication deployed by
Draghi in answering questions about a) the ECB’s (unchanged)
economic and inflation outlook (endless references to ‘technical
factors’ to explain weakness, and a reversion to focusing on
core CPI rather than headline, along with long-term inflation
expectations), and b) the risks posed by the Ukraine/Russia
crisis (too early, difficult to judge) bordered on the
cringe-worthy,” Marc Ostwald, strategist at Monument Securities
in London, wrote in a note to clients.

Reforms or not, Italy has slipped into recession with a
second straight quarter of economic contraction. As for Germany,
as a major trade partner of Russia, its problems go well beyond
the disappointing showing in its most recent factory orders
data. German business sentiment fell in July for the third
straight month, the DAX index is down 10 percent over 30 days
and some economists predict that GDP data for the second quarter
will show a contraction.

Inflation for the euro zone now stands at 0.4 percent, the
lowest since October of 2009. And while Draghi was at pains to
assert that long-term inflation expectations remained
well-anchored, some market prices seem to suggest otherwise.
Both German and Italian bonds indicate that investors expect
just 0.5 percent of annual inflation over the next five years,
according to so-called break-even rates derived from
inflation-linked securities. Given that the ECB has a target of
just under 2.0 percent inflation, this pretty well justifies a
view that the markets are losing faith that the central bank can
or will fulfill its mandate.

But still, we shall shortly have a consultant on hand who
will, in due course, help to set the ABS market to rights.

Things are looking up.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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