ECB – stick or twist?

February 6, 2014


The European Central Bank meets today with emerging market disorder high on its agenda.

It’s probably  too early to force a policy move – particularly since the next set of ECB economic and inflation forecasts are due in March – but it’s an unwelcome development at a time when inflation is already uncomfortably low, dropping further to just 0.7 percent in January, way below the ECB’s target of close to but below two percent.

If the market turbulence persists and a by-product is to drive the euro higher, which is quite possible, the downward pressure on prices could threaten a deflationary spiral which ECB policymakers have so far insisted will not come to pass.

But what to do? A small interest rate cut from 0.25 percent to somewhere just above zero is hardly going to be a game changer and the ECB has already said it won’t prime banks with long-term cheap money again unless they commit to lend into the real economy.

With stress tests looming and those same banks being told to deleverage and build up capital that is anything but straightforward though given the downward pressure the bank tests are likely to exert on lending there is certainly a case for an LTRO if banks do commit to pass the money on to businesses.

Parallel plans to buy securitised bank loans if they could be packaged as asset backed securities – which have been floated by Mario Draghi – are, we are told, a long way off and the central bank is unlikely to strengthen its forward guidance given the British experience.

The ECB has discussed ceasing soaking up money it spent buying sovereign bonds during the euro zone’s debt crisis. Ending “sterilisation” would inject about 175 billion euros of liquidity into the financial system which would ease strains in euro zone money markets but do little to raise prices.

That leaves printing money – one of the ECB’s last unbroken taboos. We’re not anywhere near that yet but if deflation really did threaten then it’s far from impossible largely because, as Japan has shown, it’s one of the few levers that could get prices rising again.

Absent action today, Draghi’s hour-long news conference will be even more minutely scrutinized than usual.

The Bank of England has a different battle – persuading markets and British people and companies that interest rates won’t rise soon. It too won’t act at today’s policy meeting, or any time soon, but strong growth means the odds of a rate rise this year are tumbling all the time unless the emerging market shock is profound and protracted.

Next week’s quarterly inflation report could be the moment when Mark Carney gives a hint about the future take on forward guidance after the UK unemployment rate shot down to his trigger point in months, rather than the years he expected it to take.

The Czechs have a different problem still. With rates already near zero they intervened heavily in November to weaken the crown and avert deflation. Despite the broader market wobbles, a commitment by the central bank, which meets today, to keep the crown on the weaker side of 27 per euro going into 2015 has so far held good.

Ghana’s central bank looks likely to join emerging markets in having to raise interest rates in response to a currency slide and the end of the U.S. Federal Reserve’s monetary stimulus programme. On Wednesday it tightened foreign exchange rules to try to halt a slide in the cedi.

Both Spain and France hold bond auctions. After a hitch-free 2013, it will be interesting to see if the market turbulence will have any impact and whether France is now viewed as “core” or “peripheral”. Paris will sell up to 8 billion euros of 2024, 2027 and 2032 bonds. Madrid will auction up to 5.5 billion euros in 3-year and 5-year.

The Sochi Olympics are about to begin and Washington has upped the ante by warning airports and airlines flying to Russia for the Games to watch for toothpaste tubes that could hold ingredients to make a bomb on a plane. Security in Sochi, by all accounts, makes Fort Knox look like a municipal library.

A clutch of world leaders are flying in giving the opportunity for some interesting talks on the sidelines. China’s Xi Jinping and Turkey’s Tayyip Erdogan stand out. Vladimir Putin will of course be there as host.

Neighbouring Ukraine remains under the cosh after it turned its back on an EU trade deal and threw itself on Moscow’s mercies. Russia signalled on Wednesday that it could toughen demands for gas payments from Ukraine if Kiev fails to fulfil existing agreements.

Ukraine’s acting prime minister blamed confrontation on the streets for a 10-percent slide in the currency since November that drove the hryvnia below 9 to the dollar for the first time in five years. That led analysts to wonder whether the central bank would no longer prop up the currency.

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