What’s it all about, Mario?

September 4, 2014


It’s ECB day and after Mario Draghi’s recent dramatic utterances, expectation for fresh action has grown, expectations which are likely largely to be dashed.

Draghi told the world’s central banking elite in Jackson Hole last month that market inflation expectations were falling markedly and the European Central Bank would use everything in its power to stabilize them in order to avoid a deflationary spiral. He also ripped up central banking orthodoxy by calling for more fiscal spending by governments at the same time as redoubling economic reform efforts. How to read that?

Two possibilities spring to mind. Either Draghi (who has talked with a number of EU leaders recently) thinks he can secure fresh a  commitment on structural reform and can use that to go back to his ECB colleagues to argue they should cross the ultimate Rubicon and start printing money in return.

Or, he is disillusioned with the lack of reform to labour markets, pensions systems etc – which was the oft-forgotten quid pro quo for his game-changing “whatever it takes” pledge two years ago – and thinks the ECB has reached the end of the road in terms of what it can do and is telling the bloc’s governments it is now down to them to foster an economic revival.

Either way, his monthly press conference will be minutely scrutinized to see if he stands by his Jackson Hole remarks – which prompted Angela Merkel and Wolfgang Schaueble to ask for clarification – and whether he gives any sort of hint that QE is coming.

A Reuters poll put a 40 percent chance on the ECB conducting outright purchases of sovereign bonds by March next year but there is a question of how effective it would be.

The main impact in the U.S. and UK was to push down government borrowing costs and make credit cheaper. In the euro zone, bond yields are already at record lows. ECB research has suggested 1 trillion euros of asset purchases spread over a year could boost inflation by as little as 0.2 percentage points.

Draghi is likely to talk up progress on preparations to buy securitised loans via a revived asset-backed securities (ABS) programme but given the moribund nature of that market there is not enough to buy to make a significant difference. Bankers and regulators say reviving it will take years.

And it seems he has a lot more to do to persuade some of his Governing Council about QE. To mention anything now would be to admit the failure of the new long-term loans for banks, announced in June, before the scheme has even started. The first money will be offered to banks later this month.

With Italy back in recession, Germany contracting in the second quarter and France stagnant over the first half of the year, the case for more government spending is strong and Keynesians would say it is the best, maybe the only way to guarantee an economic boost. The problem is that Berlin remains reticent to do so and it is the one with the budget surplus that would allow it to spend most.

The Bank of England also delivers a policy decision today but despite two of its nine interest rate-setters breaking ranks last month and calling for a first rise, the absence of any wage growth has lowered the chances of any action this year. Early 2015 now looks favourite.

Sweden’s central bank should leave its key interest rate and forecast for future policy unchanged, having cut the repo rate by a larger-than-expected 50 basis points to 0.25 percent in July, the lowest level since 2010.

Despite the euro zone’s malaise, its government bonds continue to be snapped up, presumably in anticipation of further ECB largesse.
Having raised 1 billion euros with its first ever 50-year bond this week, Spain will auction up to 3 billion euros of 10- and 30-year bonds. France sells up to 9 billion euros of long-term bonds, days after a treasury bill sale where interest rates turned negative.

The other big setpiece is the summit of NATO leaders in Wales, which will focus on the return of Cold War relations with Russia and what to do about Iraq. Vladimir Putin has got his retaliation in first by whistling up major exercises of strategic missile forces responsible for Russia’s long-range nuclear arsenal.

Wednesday saw a lot of conflicting talk on a possible ceasefire in Ukraine. The last word, from Ukraine’s President Petro Poroshenko, who will be in Wales, was that he hoped a peace process could begin on Friday when talks in the Belarussian capital of Minsk resume.

Putin said he and Poroshenko largely agreed on how to end the conflict and outlined seven steps that included a prisoner exchange and the creation of a humanitarian corridor for refugees and aid supplies. But Ukraine’s prime minister later accused him of attempting to deceive the West and avoid new sanctions.

Paying a symbolically loaded visit to the Baltic state of Estonia before the NATO summit, U.S. President Barack Obama said it must make concrete commitments to help Kiev modernize and strengthen its security forces, with Georgia and Moldova getting similar help. That won’t go down well in the Kremlin.

NATO leaders will set up a “spearhead” rapid reaction force, potentially including several thousand troops, that could be sent to a hotspot in as little as two days, officials say. Eastern European NATO members have appealed for NATO troops to be permanently stationed on their territory but that won’t happen because of cost and the reluctance to break a 1997 agreement with Russia under which the alliance committed not to station significant combat forces in the east.

Washington also wants to see greater defence spending in Europe, reversing recent years of sharp declines, and is seeking potential partners for joint military action against Islamic State militants in Iraq, following the beheading of a second U.S. journalist held captive.
U.S. air strikes against the militants have significantly hampered the militants’ advance across northern Iraq.

Britain and Australia are potential candidates. Germany has said it was in talks with the United States and others about possible military action against Islamic State but made clear it would not participate. France, which was left on a limb when Obama backed down from the threat of strikes on Syria following a major chemical attack a year ago, was thought to have been reluctant but statements from the Elysee yesterday suggest it may be amenable.

The West’s new round of threatened sanctions is also gathering pace with France pulling delivery of the first of two helicopter carriers to Russia, having previously insisted it would go ahead. That suggests Paris is anything but convinced about Moscow’s talk of a ceasefire.

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