By Pierre Briançon
The European Central Bank this week has to convince markets it is ready to act on events that may never happen.
The central bank’s governing council meeting on March 7 will consider whether the eurozone’s economic slowdown will worsen. That will determine the policy steps the ECB might take, or the ones it might hint at taking in the future — “forward guidance” in central bank lingo.
ECB insiders say the main step under consideration is a new long-term liquidity facility for eurozone banks. The “targeted long-term refinancing operations” (TLTRO) the ECB launched in 2014 and 2016 provided banks with four-year loans at low interest rates, on condition that they increased their lending. The latest of these loans mature next year. Some of the eurozone’s most challenged banks (think Italy) need a similar facility badly.
If it offers a new liquidity facility, the ECB will, however, have to insist that it is not acting just to help Italian banks, and that its decision is motivated by general monetary policy considerations. Some European bankers note that they have “no real need” for a new TLTRO facility, considering that liquidity is abundant in the banking system and that companies can easily borrow. If strict conditions are attached, the eurozone’s best-funded banks might prefer to pass this time.
The ECB could, however, opt for an unconditional facility, argues Gilles Moëc, chief European economist at Bank of America. An “LTRO” wouldn’t require banks that participate to increase their lending activities. It might find more takers, ease banks’ overall funding costs and help smooth the impact of a possible slump on the economy.
The ECB might also signal that it is ready to gradually phase out the negative rate on its overnight deposit facility — i.e., the 0.4% it charges banks hoarding their excess liquidity at the central bank. The ECB was the only western central bank to adopt this measure in the post-financial crisis period. It has been described as a “tax on banks” by the financial industry. Frederic Oudea, the CEO of France’s Société Générale, has even talked about “the poison of negative rates”. Frederik Ducrozet, global macro strategist at Pictet, ventures that the central bank might want to send a signal by increasing the negative rate from -0.4% to -0.2%.
Since last year, the ECB’s forward guidance has been that interest rates would remain at their current level at least “throughout the summer”. Markets, for their part, are betting that a raise won’t happen before the spring of 2020.
“An interest-rate increase now would damage their communication plan, hence their credibility,” a European banker acknowledges.
For now, some of the potential headwinds to Europe’s economy have moved further over the horizon, such as a worsening of US-China trade relations, or a hard, no-deal Brexit. Some members of the ECB ruling body say that there would be no point in relaxing monetary policy if, in a few month’s time, it appears that the economy has avoided the worst.
The governing council’s decision is complicated by the fact that the institution is living through a changing of the guard that will culminate with the end of President Mario Draghi’s term and his replacement in October this year. And economic developments are upending the ECB’s plans for a smooth phasing out of its loose monetary policies. The massive sovereign bond buying program known as quantitative easing stopped in December and there is no plan to resume, but the central bank keeps reinvesting the bonds’ proceeds when they come to maturity.
That means that the old balance within the ECB ruling body between “doves” and “hawks” is blurring.
Central bankers who hope to have a shot at the ECB’s top job will have to court eurozone governments in the months to come. This is the moment when doves are making hawkish sounds, and hawks are growing dove wings.
Beyond policy considerations, that makes the governing council’s decisions harder to predict than usual.