Another 'yes but...' from Karlsruhe

The German Constitutional Court just released its final verdict in the case against the ECB’s OMT programme. The Court rejects the complaint but does only give half-green light for OMT. < Summary Line Germany’s Constitutional Court just released its ruling in the case against the ECB’s OMT programme. The Court officially rejects the complaint against OMT. However, the details of the Court’s ruling suggest that rejecting a complaint does not necessarily mean that the Court embraces OMT. Although we are no legal experts, the bottom line of the Court’s ruling seem to be: the Court grudgingly acknowledges the ECB’s independence on monetary policy matters and that European legal matters do not fall into the responsibility of the German Court. Moreover, the Bundesbank can only participate in the OMT under certain conditions. Remember, the OMT programme has been the ECB’s strongest weapon during the peak times of the euro crisis and it is a programme which has never cost a single euro. The OMT has been the fundament under Mario Draghi’s famous “whatever it takes” words. It is the programme with which the ECB announced to buy government bonds of crisis-stressed countries under certain conditions, as e.g. that the country needs be in a bailout programme. The “whatever it takes” words combined with OMT were a game changer during the darkest times of the euro crisis, giving financial markets the impression that the ECB could be a last lender of resort for the Eurozone. Consequently, spreads between government bond yields narrowed again. But the legality of the programme has been challenged by 37,000 German plaintiffs who argue that OMT violates the EU’s prohibition on the “monetary financing” of governments. Last year, the German Court had asked the European Court of Justice for legal advice (which is different from delegating the entire case to the European level). The ECJ’s advice was clearly supportive for the ECB. With today’s final ruling, the German Constitutional Court confirms the ECJ’s ruling but also indirectly criticizes the ECJ for not having investigated deep enough whether ECB’s own assessment on need for OMT was justified. In its ruling, the German Court states that it took the ECB’s own assessment for granted. While the German Court has rejected the case against the OMT, it still has put conditions on the Bundesbank’s participation. Namely: bond purchases should be limited in volume and should not be announced beforehand. Moreover, purchased bonds should only held until maturity in exceptional cases. The entire case has not only brought German opposition against the ECB’s non-standard monetary policy measures into court rooms, it has also been a nice illustration of the ongoing struggle and difficulties in Europe and the Eurozone to delegate powers and responsibility from the national to the European level. Similar to the British referendum in two days from now, the German Court’s ruling had the potential to shake the European Union or at least the monetary union to its very foundations. Fortunately, it did not. This ruling on a programme which has never ever been used gives the ECB enough room and backing to continue with QE and to stand ready to eventually fight any emergencies on financial markets in case of a Brexit-vote on Friday morning. At the same time, however, the ruling was not convincing or strict enough that it will stop German opposition against current ECB policies or prevent new lawsuits against the ECB. It was a typical “yes, but…” ruling from Karlsruhe. Some could even be tempted to call the Court a sore loser who is still struggling to find a balance between European and national interests and powers. Clearly not the only one in Europe currently.

German economy surges in Q1

The German economy grew by 0.7% QoQ in the first quarter of 2016, from 0.3% QoQ in the final quarter of 2015. The strongest quarterly performance since the first quarter of 2014. On the year, GDP was up by 1.6% (in working day adjusted terms). The GDP components will only be released at the end of the month but judging from the available monthly data and the statistical agency’s press release, growth in the first quarter was mainly driven by domestic factors. Particularly, activity in the construction sector boomed on the back of the mild winter weather. The latest recovery of the German economy lasts already for seven quarters. Without the small stagnation in the second quarter of 2014, the economy could now look back at twelve consecutive quarters of economic growth. Very impressive. Moreover, during this lucky streak, the growth drivers have changed. Initially boosted by strong industrial production and exports, the economy is currently much more driven by private consumption, construction and a bit of exports. The industrial backbone has weakened significantly. Looking ahead, at least in the near term, this new growth mix should further support growth. Against this background of a long and strong growth performance, it does not really come as a surprise that many German policymakers have become complacent, some even big-headed, or at least not being very open for criticism or proposals to further improve the economic performance. In fact, today’s data provide new ammunition for the proponents of ‘there is no need for change’. Such an attitude stands in sharp contrast with the latest round of international pressure on Germany to implement some change. After criticism on Germany’s high trade surplus and rather naive recommendations to reduce the deficit, it was then a call to increase domestic wages and investments and has now become a clear disclosure of Germany’s lack of structural reforms. First, there was the OECD calling for tax reductions. Now, very recently it has been the IMF proposing infrastructure investments and new reforms in the labour market and the pension system. While the first two phases of international criticism were easily shaken off by many German policymakers, the latest phase is actually hitting the bull’s eye. It hits the German economic establishment in the heart as they have always been the most vocal advocates of structural reforms elsewhere. Now structural reforms are coming home and it will be interesting to watch what the official reaction to the latest IMF proposals will be. After all, it has always been the German government asking for IMF involvement in the euro crisis management, due to the IMF’s uncontested expertise. However, roughly one year ahead of the next national elections, there is the risk that no new reforms will be implemented before the elections. If true, it could eventually turn out be a missed unique opportunity. Implementing new reforms in good times is always easier then implementing them in bad times. Unfortunately, it almost never happens. Today’s data are another sign of Germany’s economic strength. At least at first glance. The economy defied the financial market turmoil at the start of the year as well as the Chinese slowdown. Even if many Germans don’t want to hear it, strong domestic activity is also the result of the ECB’s loose monetary policy. At second glance, however, the strong growth performance also shows what currently is the biggest risk for the German economy: complacency. Ironically, with growth driven by construction and consumption and a government which is reluctant to follow up on international advice to implement structural reforms, the German economy has almost started to resemble peripheral characteristics.

Column: Puberende Duitsers

Als mijn kinderen op het matje worden geroepen omdat ze veel te laat naar bed gaan of veel te lang op de computer spelen, is hun defensiestrategie vooral heel hard te schreeuwen en zo snel mogelijk naar de andere te wijzen als de echte zondebok. De gespeelde opwinding is de aanvallende verdediging om hun eigen gedrag te maskeren, wetende dat de ouders liever rust hebben in huis. Dat gedrag oefenen biedt kansen voor een carrière in de Duitse politiek. Want heel hard schreeuwen en een zondebok zoeken ter afleiding van de eigen tekortkomingen is de nieuwste trend in de Duitse politiek. Duitse kritiek op de Europese Centrale Bank (ECB) is niet nieuw. In de loop van de eurocrisis hebben de Duitse centraal bankiers Axel Weber en Jürgen Stark zelfs de handdoek in de ring gegooid en zijn ze vertrokken omdat ze het niet eens waren met het beleid van de ECB. Dat de kritiek op de ECB nu uit de allerhoogste rangen van de Duitse politiek komt, is echter nieuw. Met zijn uitspraak dat het beleid van de ECB verantwoordelijk is voor de opkomst van de antimigratiepartij AfD in Duitsland ging minister van Financiën en politiek veteraan Wolfgang Schäuble te ver. Iemand die zó van regels en afspraken houdt, zou moeten weten dat de Europese verdragen de Europese politici verbieden invloed uit te oefenen op de ECB. Wat bezielt Schäuble? Meer dan een jaar voor de Duitse verkiezingen lijkt Schäuble een belangrijke doelgroep voor zich te willen claimen: de spaarders en de gepensioneerden. Dat is met afstand de grootste groep kiezers in Duitsland. Met zijn kritiek op de ECB zoekt Schäuble een externe zondebok en kan hij zich opwerpen als de grote redder. Hij speelt echter met vuur. Ook al heeft Schäuble zijn kritiek inmiddels gerelativeerd, de geest is uit de fles. Schäuble heeft de Duitse kritiek op de ECB gelegitimeerd. En zo is een nieuw rondje hevige ECB-bashing begonnen, door politici, wetenschappers en zelfbenoemde experts. Gevolgen voor het beleid van de ECB zal dat niet hebben. De Duitsers staan te geïsoleerd in de ECB om een verschil te maken. Om een oud citaat van Bild-Zeitung te misbruiken: Duitse kritiek hoort bij het ECB-beleid zoals tomatensaus bij spaghetti. Het ergste aan de kritiek is dat ze de aandacht afleidt van de echte problemen in Duitsland. De banksector en het pensioenstelsel zijn al langer aan hervormingen toe. De lage rente is niet de oorzaak van die problemen, alleen brengt de lange rente de problemen nu sneller aan de oppervlakte. Ook leidt de ECB-bashing de aandacht af van de vraag waarom de regering bij negatieve rentes op staatsobligaties niet méér investeert, en waar de grote Duitse stap naar meer integratie in de eurozone blijft. Voor de toekomst van de eurozone en voor de rust in mijn gezin is het te hopen dat het pubergedrag snel verandert. Deze column verscheen vandaag in het Belgische dagblad "De Tijd"

ECB meeting - It ain't over till it's over

What was expected to be a dull first meeting of the year, turned out to be an exciting ECB meeting with ECB president Mario Draghi opening the door widely for new ECB action in March. While today’s ECB meeting will again feed bold speculations about what could happen in March, the question remains whether Draghi will really be able to deliver on his promise. No action today but probably in March. This is the bottom line of today’s ECB meeting. Interest rates and all else were kept on hold. However, ECB president Draghi sounded much more concerned about the outlook for the Eurozone economy, both in terms of growth and inflation, than six weeks ago. Draghi explicitly mentioned the renewed sharp drop in oil prices, the appreciation of the euro (let’s not forget, the side-effect of Draghi’s monetary policy own goal in December) and the slowdown of emerging markets and China. In addition, Draghi mentioned the volatility in financial and commodity markets as one of the factors behind the increase in downside risks since the start of the new year. Against this background, Draghi sent several strong messages, hinting at new ECB action at the next ECB meeting. First of all, Draghi reintroduced the concept of explicit forward guidance by stating that “we expect them [key ECB interest rates] to remain at present or lower levels for an extended period of time”. In our view a clear indication that despite having announced the lower bound for interest rates several times of the last years, the ECB is again considering cutting rates. Moreover, an even stronger hint at new action was given with the sentence “it will therefore be necessary to review and possible reconsider our monetary policy stance at our next meeting in early March”. According to Draghi, “work will be carried out to ensure that all the technical conditions are in place to make the full range of policy options available for implementation, if needed”. A bit of a surprise as we thought that all possible options had already been on the table back in December. Financial markets reacted enthusiastically to Draghi’s hints and the euro exchange rate dropped immediately. The question, however, is whether and what the ECB can really deliver in March. Let’s not forget that the outcome of the December meeting looked like a compromise between doves and hawks, with the ECB eventually delivering less than markets had expected. Admittedly, at least the external environment for the Eurozone economy has worsened since the December meeting but it is unclear what the ECB can do to tackle low prices. It is hard to imagine that oil purchases will be on the agenda in March. Nevertheless, unless oil prices rebound in the coming weeks or the Eurozone economy surprises to the upside, it will again be difficult for the ECB not to deliver with new action in March. Judging from today’s comments, the most likely common denominator for both hawks and doves should be another rate cut (perhaps the idea of a two-tier deposit rate will be dug out again), possibly combined by another marginal fine-tuning of QE. All in all, today’s ECB meeting shows that Mario Draghi is always in for a good surprise. Every time it looked as if the ECB was done with its stimulus and willing to wait until all measures have had enough time to unfold their full impact, Draghi puts another log on the fire. Even if the big question remains whether Draghi can actually make markets’ new dreams come true. We might not hear Draghi sing at a press conference but for now Draghi has today again reminded everyone that “it ain’t over till it’s over”.

ECB gifts disappoint after unwrapping

Santa Mario did not turn into the Grinch, the Christmas monster. However, his long-awaited early Christmas afternoon left many market participants disappointed like small kids who receive less and smaller presents than expected on Christmas eve. At its long-awaited meeting, the ECB today cut the deposit rate to -0.3%, from -0.2%, while leaving all other interest rates unchanged. In addition, the ECB decided to extend the deadline of QE purchases to at least until March 2017, from earlier September 2016, and to introduce other measures, broadening the scope of the monthly purchases. For the first time in a long while, ECB president Draghi underachieved and delivered less than the market consensus had expected. As a result, the euro appreciated and bond yields increased immediately after the policy decision. So what exactly did the ECB decide? Basically five things: i) a 10bp cut in the deposit rate; ii) an extension of the formal deadline of monthly QE purchases to at least March 2017, from earlier September 2016; iii) reinvestments of the principal payments of the securities purchased “for as long as necessary”; iv) the inclusion of regional and local government bonds in the monthly purchases; and v) an extension of fixed-rate tender procedure and full allotment for refinancing operation until the end of 2017. What the ECB did not announce was a bigger cut of the deposit rate, a cut in the refi rate or an increase of the monthly asset purchases. The discrepancy between what the ECB did and did not announce raises the question of the ECB’s ratio behind it and the arguments. Looking at the ECB’s macro assessment, it looks as if almost unchanged growth and inflation forecasts as well as a positive assessment of the impact from QE up to now laid the grounds for the ECB’s rather reserved policy reaction. In more detail, ECB staff now expects GDP growth to come in at 1.7% next year (unchanged) and 1.9% (from 1.8% in September) in 2017 and inflation to accelerate to 1% (from 1.1% in September) next year and 1.6% (from 1.7%) in 2017. The underlying story is still the same one of a gradual recovery with downside risks to growth and inflation. According to Mario Draghi, all ECB measures taken so far have increased the inflation forecasts by 0.5 percentage points for 2016 and 0.3 percentage points for 2017. They also boosted GDP by 1 percentage point over the period 2015 to 2017. Moreover, the ECB’s decision to deliver only a very bare minimum of additional monetary stimulus indicates that the hawks at the ECB are stronger than many market participants had thought and that the ECB itself was surprised by the latest resilience of the Eurozone economy and the estimated positive impact of QE so far. Looking ahead, today’s decision still leaves all doors open for more monetary stimulus, in case the outlook for both growth and inflation were to worsen again. In the short term, however, it leaves the destiny of the euro exchange rate mainly in the hands of the Fed. For ECB watchers, today’s meeting was an important lesson not to take Draghi’s overachieving for granted. All in all, today’s ECB meeting, which was expected as an early Christmas present party, turned out to be a bit of a disappointment, maybe better matching the current Zeitgeist in the Eurozone: no copious and excessive gift party but more introvert modesty.

Rethinking the overachiever

Mario Draghi’s bold comments have raised the bar for the December meeting to a very high level. What could the ECB actually do? Even after some sleep and several internal brainstormings, it is not fully clear to us why ECB Draghi went as far as he did with his comments during Thursday’s ECB press conference. In our view, it would have been more than sufficient to use the phrase “the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting”. This alone would have been a clear opener for more monetary action in December. Instead, Draghi himself brought forward the possibility of lowering the deposit rate, mentioned that some Governing Council members had already been in favour of more action at the Thursday meeting and hinted at new, unprecedented action by stating that the Governing Council had tasked internal committees to investigate further measures. All in all, a “work-and-assess” mode that has put market expectations to a (too) high level. The question of why Draghi chose for such boldness will remain unanswered. Is the ECB just overly concerned or are we back in the good old days when central banks had exclusive insight information on markets and economies? Hopefully, the meeting minutes will shed some light on these questions. Looking ahead, all eyes will now be on the 3 December meeting. In our view, despite all boldness, new action is not a done deal, yet. It will be conditional on the next batch of ECB staff projections and, particularly, the inflation forecasts for headline and core inflation in 2017 (1.7% and 1.6% respectively in the September forecasts). Admittedly, inactivity in December would clearly be counterproductive and would lead to a negative market reaction, eventually still forcing the ECB to act. In short, Draghi’s boldness has put the ECB into a position from which it will be very hard to escape without any new action. Based on Draghi’s comments on Thursday, what is the most likely action the ECB can deliver on 3 December? Given that not all members of the ECB’s Governing Council seem keen on stepping up QE, as they either deem it too early or simply ineffective (just think of Liikanen or Weidmann), returning to traditional monetary policy instruments seems like the most viable option. A cut of the deposit rate by 5-10 bp and a cut of the refi rate to zero could be easier digested by the ECB’s own QE critics. The fact that Draghi had several prepared statements at the Thursday meeting on why a rate cut would not lead to a credibility loss (despite last year’s comments that the ECB had reached the lower bound) and the focus on real not nominal rates, suggests that the ECB did already have a very intense discussion on this option. Draghi’s comments that the Governing Council had tasked all relevant committee to investigate other possible measures suggests that the ECB itself is not fully concerned that a simple “more of the same” will do the trick. Stepping up the current QE by either increasing the monthly size or the length of the programme is on the one hand hard to achieve (given that markets have already dried up significantly) and on the other hand will probably not have a huge impact on the economy. In our view, however, it is doubtful that the same committee which prepared QE last year will now all of a sudden find completely new measures no one else had ever thought about before. In theory, possible options might be purchases of corporate bonds, stocks or government bonds of non-Eurozone countries. Is it likely? In our view, not (yet). Notwithstanding the above, the ECB might still be tempted to deliver something on QE. Just in order to meet high market expectations. In this regard, some minor, rather cosmetical, changes to the current QE programme should not be excluded. An increase of the monthly size by 5 to 10bn and an extension of the minimum deadline to January 2017, instead of the current September 2016. The ECB might even consider dropping the reference to a precise minimum deadline. At first glance, this would make the programme look more open-ended than it currently is. However, at second glance, such a move could backfire in a situation in which inflation expectations start to increase before September 2016. Another more elegant way to do something more in terms of QE (probably preferred by the members of the Governing Council more critical of the programme) would be lowering the minimum yield at which the ECB can purchase bond (currently -20 bp), in line with the rate cut on the deposit facility (given the fact that it is not entirely clear whether there is an automatic link between deposit rate and the rate limit for QE purchases). That could also shift the longer end of the yield curve downwards. In the same vein, a further rate cut on TLTROs could be considered. All in all, a rate cut (also applied to the different types of unconventional monetary policy instruments), possibly combined with some cosmetic tweaking of QE look like the most likely next step for the ECB. Will it help? The ECB thinks it does. And, indeed, judging from Thursday’s market reaction, it should – at least initially – weaken the euro exchange rate. However, as it always needs two to tango, this ECB strategy would only work if the Fed would really start hiking interest rates. In this regard, any market and ECB enthusiasm could easily end with a hangover two weeks later when the Fed meets on 16 December.

Draghi gives dovish present on his birthday

What a difference only a couple of months can make. Remember that back in March and April, the ECB was very upbeat on the Eurozone economy, with ECB president Draghi obviously enjoying the positive impact from QE (and even its pure announcement effect)? Now, just a couple of months later, the ECB has become less upbeat. After today’s ECB meeting, president Draghi sounded rather dovish, keeping the door for stepping up QE open. The somewhat more downbeat economic assessment is mainly the result of weaker growth in emerging markets. The ECB still expects a gradual recovery, albeit at a somewhat weaker pace. This was also reflected in the latest ECB staff projection, which foresee GDP growth to come in at 1.4% this year (from 1.5% in the June projections), 1.7% in 2016 (from 1.9%) and 1.8% in 2017 (from 2.0%). As regards inflation, ECB staff projections were revised downwards significantly on the back of lower energy prices. In the latest projections, ECB staff expects inflation to come in at 0.1% this year (from 0.3%), 1.1% in 2016 (from 1.5%) and 1.7% (from 1.8%). All these projections, however, have to be taken with a large pinch of salt as the cut-off date was much earlier than usual and therefore before the peak of latest market turmoil. Normally, the cut-off date of ECB staff projections is around the 20th of the month, now it was the 12th. The early cut-off date is an additional explanation for the ECB’s caution and new emphasis on downside risks. As regards the ongoing QE programme, the ECB announced that it would increase the so-called “share issue limit” from initially 25% to 33%. This decision was taken after a first assessment of the first six months of QE and means that the ECB could now purchase up 33% of each government bond issuance (as long as this would not give the ECB a blocking minority). While some market participants saw this measure as a first step towards stepping up QE, it is in our view a more technical measure, reflecting the fact and fear that the ECB could run into troubles achieving its monthly target of 60bn euro. Needless to say that the drop in inflation projections has revived the deflation versus disinflation debate within the ECB. It is the same debate the ECB had at the end of last year when discussing the need for QE. It is the debate on whether low or negative headline inflation rates, mainly triggered by dropping energy prices, do lead to deflationary expectations or are simply a blessing for the economy, increasing consumers’ purchasing power. In today’s comments, Draghi suggested that currently the ECB was still tending to the “it’s a blessing” explanation. Still, Draghi made two important comments which in our view set the door for more QE a bit more open: the small addition of “or beyond” to the targeted duration of September 2016 for the QE programme and the phrase that the Governing Council emphasized its “willingness and ability to act, if warranted, by using all the instruments available within its mandate and, in particular, recalls that the asset purchase programme provides sufficient flexibility in terms of adjusting the size, composition and duration of the programme.” The door to more QE is open, even if Draghi also stressed that the ECB today had not discussed this possibility, but will the ECB also walk through this door? To answer this question, one has to go back to the initial QE discussion in late 2014. In our view, back then the deflation threat was a welcome stalking-horse to convince even die-hard monetarists in the Governing Council to sign off QE. Of course, successful QE would eventually also increase inflation and inflationary expectations but only indirectly and as a second round effect. The main and most imminent impact from a successful QE would go through a weaker exchange rate and stronger economic growth. Keeping this in mind, lower inflation projections will not per se lead to an increase of QE. To really see the ECB stepping up QE, the Eurozone recovery would need to falter first. On his birthday, Mario Draghi did not receive but actually gave a present to financial markets, stressing the ECB’s determination to do everything to support the Eurozone economy.

German inflation in August signals new headache for ECB

Based on the results of six regional states, German headline inflation remained unchanged at 0.2% YoY in August. On the month, German price development was flat. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation remained unchanged and stands now at 0.1% YoY. A quick look at the available components at the regional levels shows that low headline inflation is not only the result of lower energy prices but also some tentative second-round effects on consumer goods. At the same time, higher prices in the service sector indicate that there is clearly no risk of deflation for the German economy. Interestingly, the weakening of the euro exchange rate is still not visible in significantly higher import prices. To the contrary, import prices continue to fall, with latest data showing a 0.7% YoY drop in August. Looking ahead, the latest plunge in commodity prices should leave its marks on headline inflation in the coming months. Even a drop into negative territory cannot be excluded. Against this background, reaching the official Bundesbank projection of 0.5% annual inflation for the entire year 2015 has become highly unlikely. It would actually require headline inflation to average 0.9% in the remaining months of the year. In our view, headline inflation should stay close to but above zero for the post-summer months before gradually increasing towards 1% YoY. Consequently, these low inflation rates should continue supporting private consumption. While low inflation or even negative inflation rates are a blessing for German consumers, they could become a new headache for the ECB. As at the end of last year when the discussion about a possible QE started, the ECB is again confronted with deflationary forces. Or to be more precise, with disinflationary forces. With commodity prices now significantly lower than back at the end of 2014, the ECB will have to decide whether low or negative inflation rates are rather positive (ie strengthening purchasing power and domestic demand) or negative (ie contributing to dropping inflation expectations). This discussion should be sharpened by the latest round of ECB staff projections, which in our view should show a significant downward revision of the ECB’s inflation forecasts. The last edition of the ECB projections back in June included the technical assumption of an average oil price of 64 USD/b this year, 71 USD/b next year and 73.1 USD/b in 2017 (based on future contracts). Even if the cut-off date of the latest projection round was probably slightly before the peak of recent market turmoil, these oil price assumptions do now look very outdated. Just doing some quick back-of-the-envelope calculations suggests that the new commodity environment could lead to downward revision of the ECB’s inflation projections of between 0.4 and 0.6 percentage points for 2016 and 2017. In June, the ECB projected inflation at 1.5% in 2016 and 1.8% in 2017. Admittedly, the ECB projections are much more complex and sophisticated than our back-of-the-envelope calculations. However, anything else than a clear downward revision of the ECB’s inflation numbers next week would be a surprise. All in all, the latest plunge in commodity prices will clearly revive the good vs bad deflation debate in the EuroTower. For the time being, this should not yet lead to new policy action. However, recent comments by ECB chief economist Peter Praet confirm our view that latest market developments have rather increased than decreased chances for more QE.

Eurozone - Leap of faith

As expected, today’s ECB meeting was all about Greece. ECB president Draghi did not only answer many questions, he also delivered tangibles for Greece: a minor increase of ELA for one week. Together with the Eurogroup’s parallel decisions to grant bridge financing of 7bn and a principle agreement to grant a third bailout package, the Eurozone’s key players took an enormous leap of faith with Greece. As regards the macro-economic situation, the ECB’s analysis and outlook did not change from last month’s. The ECB still expects a broadening of the Eurozone’s economic recovery and gradually increasing inflations rates. Interestingly, the ECB added the slowdown in emerging markets to its downside risks to growth. Remarkably, despite the broadly unchanged macro-economic assessment, Draghi gave an important hint that market participants should forget about tapering any time soon. The ECB reincluded an important paragraph to its introductory statement, saying that the ECB would “continue to closely monitor the situation in financial markets, as well as the potential implications for the monetary policy stance and for the outlook for price stability. If any factors were to lead to an unwarranted tightening of monetary policy, or if the outlook for price stability were to materially change, the Governing Council would respond to such a situation by using all the instruments available within its mandate.” In our view, a clear sign that – contrary to what the ECB said in early June – the ECB is concerned about the sell-off in bond markets and would react by stepping up, rather than reducing its QE activities; at least as long as the recovery is as fragile as it currently looks like. Most of the press conference was dedicated to Greece. Here, Draghi gave many long explanations and statements on the current state of play. The most remarkable two comments and announcements were: i) the ECB decided to increase ELA for Greek banks by 900 mln euro for one week. With this decision, the ECB fulfilled the request of the Bank of Greece and at least symbolically rewarded latest progress in the Greek crisis. ii) Draghi joined the current choir on debt relief for Greece, saying that “it is uncontroversial that debt relief is necessary”; and iii) Greek bonds would become eligible for the ECB’s QE programme once there is a bailout deal and the ESM has disbursed the first tranche of the money. And there was more news from the Eurozone today. After the principle decision that the Eurozone would offer Greece a 7bn euro bridge financing through the Commission’s rescue fund, the EFSM, the Eurogroup today also reached out to Greece. At the same time that the ECB press conference started, the Eurogroup issued a written statement, welcoming last night’s parliamentary green light for the Greek reforms. Moreover, the Eurogroup said that it would in principle grant a three-year bailout package to Greece, obviously only when all conditions as laid out in Monday’s agreement are met. All in all, let’s not get carried away by too much pathos. The Eurozone finance ministers just confirmed what their chiefs had already decided on Monday. Let’s stick to facts: Greece last night took an important first step towards receiving a third bailout package. More important and complex steps and negotiations will still follow. The decision to grant bridge financing as well as today’s ECB decision to increase ELA are no game changer, yet, but at least a symbolic leap of faith.

Eurozone: A Pyrrhic 'no'?

The ‘no’ vote in yesterday’s referendum seems to have strengthened Tsipras’ position. However, what looks like a stunning victory could quickly become a Pyrrhic ‘no’. The Greek people yesterday sent a strong message to the rest of Europe: a ‘no’ against austerity. According to the latest results, more than 60% of the Greek people said ‘no’ in the referendum. Officially, this ‘no’ was against a proposal from Greece’s creditors on 25 June to extend the bailout agreement against certain conditions. Whether the ‘no’ was also a vote against Greece’s membership within the Eurozone will never be clear. Ahead of the referendum, there was lots of speculation on what would happen if…now that there is clarity on the outcome of the referendum, the only thing that is clear is that nothing is clear. Only the coming days and hours will show what all involved players are really up to. In our view, the most likely next step is that the Greek government will want to return to Brussels to negotiate a new package with its Eurozone creditors, now backed with a strong mandate of the Greek people. It is hard to tell what the new demands or proposals of the Greek government will really be. The range of demands varies highly between different members of governments, ranging from a democratic change for Europe to no new austerity. The only element that will clearly be in any new Greek proposals is debt relief. In our view, the Eurozone will wait for Greece to make the first move. Initially, the Eurozone will insist on the technical issue that there no longer is a Greek bailout programme and that the Greek government would have to apply for a new programme. Interestingly, the German parliament and other parliaments would have to agree to a start of new formal negotiations. In this regards, it is noteworthy that new negotiations with Greece could also put the Eurozone’s inner stability to a test. It will not be easy to find a common strategy for any new negotiations that will be embraced by all Eurozone countries. Still, even if it is hard to see that the other Eurozone countries will give their Greek colleagues a warm welcome and that new negotiations are more fruitful than over the last five months, the outcome of the referendum will push the rest of the Eurozone to at least start talking. In theory, a compromise could be possible. A deal with less austerity but serious reforms, including tackling corruption and tax evasion, in Greece, obviously, would be the best outcome. Such a deal could even include some debt relief, but at the end of the ride and not upfront. This, however, would require that all parties involved could jump over their own shadows. In particular, the bad blood created by sometimes excessively inadequate language will be a large liability for any new negotiations. While politicians in the Eurozone are preparing for possible new talks, it is once again up to the ECB to do the dirty work. Today, the ECB will have to decide on what to do with ELA. Apparently, the Greek central bank applied for an increase of ELA. The ‘no’ has not made the ECB’s life any easier. With every step that Greece is moving closer to total default or even a Grexit and Greek banks are losing deposits, it will be harder for the ECB to label Greek banks as solvent, and thereby eligible for ELA. In our view, the ECB will not be the one pulling the trigger on Greece. As long as Eurozone politicians will signal their willingness to negotiate with Athens, the ECB will keep ELA at its current levels – even if it will create a bigger headache in Frankfurt every day. Still, this strategy will come to an end on 20 July. If Greece is not able to reimburse the ECB and would default on the bond, it is very hard to see the ECB continuing ELA. All in all, the ‘no’ vote in the referendum will lead to the expected uncertainty. At the current junction, the ‘no’ vote is not (yet) a first step towards a Grexit. Even if Eurozone politicians won’t have a huge appetite to talk to possibly triumphant Greek counterparts, they will never refuse initial talks. How such negotiations will end is hard to tell. A lot will depend on how ready to compromise both the Greek government and the other Eurozone governments are. We still think that eventually a sustainable compromise can be reached. However, the risk for a Grexit has never been higher than today. To a large extent, the current situation brings the Eurozone and Greece back to square one. Square one as it looked like in January: the Greek people have voted against austerity, the Greek government wants debt relief from its Eurozone peers and the Eurozone has troubles finding a united reaction. The big difference with January, however, is that lots of bad blood is on the floors, Greek banks are closed and Greece does not have a bailout programme. These three factors clearly do not argue in favour of a strong Greek position vis-à-vis the rest of the Eurozone. Did Tsipras celebrate a Pyrrhic ‘no’?

Eurozone: It's (never) too late?

Another last-minute stunt from Tsipras could not avoid the end of the bailout programme and Greece missing the reimbursement of an IMF loan. Never a dull moment. The events in the Greek crisis over the last 24 hours once again had interesting twists and turns but this time around the hard facts remained unchanged: Greece has missed its payment to the IMF, the bailout programme has expired and the referendum is on track. Greek Prime Minister Tsipras pulled another rabbit out of his hat yesterday, submitting a new proposal to the Eurozone creditors. The proposal was a request for a two-year programme funded by the ESM (without IMF involvement). This programme would cover all Greek financial needs and would also include debt restructuring. According to media reports, the proposal did not include any new reform measures. Tsipras’ proposal came hours after reports that the European Commission had suggested that a new compromise might still be possible. Whether Tsipras’ move was a kind of late self-persuasion or just standard brinkmanship remains unclear. In our view, it was a last attempt to gain the upper hand in the ongoing blame game between Greece and the Eurozone, showing Greece’s so-called willingness to compromise. In a telephone conference last evening, the Eurozone finance ministers quickly discussed the proposal but the conclusion was clear: nice try but far too late. Eurogroup chairman Dijsselbloem said that “the political stance of the Greek government doesn’t appear to have changed”. Requests from Tsipras for an extension of Greece’s bailout programme or debt relief were not possible. Nevertheless, the Eurogroup will have another conference call tomorrow. All of this means that Greece will not reimburse an IMF loan and the official bailout programme has expired. As regards the IMF loan, we stick to our view that this will not trigger a credit event. According to the IMF rules, missing a payment will now start an entire procedure with several steps which after a period of up to 24 months could lead to the expulsion of Greece from the IMF. In addition, after one month, the EFSF would have the legal possibility to reclaim all already paid loans to Greece. Something, which in our view would only happen if the political will to keep Greece within the Eurozone at that moment in time would have entirely disappeared. All in all, missing the reimbursement of the IMF pushes Greece into the same league as Zimbabwe, Sudan and Somalia, but it would not lead to further crisis escalation ahead of the referendum. The same holds for the expiration of the second bailout programme. Technically-speaking, nothing will change in the short run. However, the fact that the programme has officially expired means that, legally, it cannot be extended anymore. No matter what the outcome of the referendum and consequent steps of the Greek government will be. From a legal and technical perspective, any new compromise would now start from scratch and would have to be a third bailout programme. In sum, yesterday’s events marked another symbolic step in the Greek crisis but also confirmed that the issue between Greece and its Eurozone creditors goes beyond numbers and substance. It’s the clash between an ideologically-driven government and a consensus-driven and compromise-oriented Eurozone. Even if it is tempting, we will refrain from sharing our memories of famous songs referring to “too late” but one thing is sure: only a miracle could solve the current stand-off in the Greece crisis before this weekend’s referendum.

Final showdown - this time for real?

It seems as if the excessively used words of “final showdown” in the Greek crisis are finally here. And they are for real. Honestly, it becomes harder and harder to comment on the Greek crisis in a meaningful way. Yesterday was another example of confusion and diffusion. The day started with news reporting that Tsipras had told the Greek parliament that some creditors had rejected the Greek proposals. Later in the day, it became clear that the IMF had indeed issued a counterproposal, amending and integrating the Greek offer. No break-up of the negotiations, but normal exchange of proposals in an exhausting bargaining process. Later, the Eurogroup meeting ended with another unexpected twist. While earlier in the day, expectations were that the Eurogroup would negotiate for as long as needed to reach a deal with Greece, the Greek crisis took yet again another dramatic turn. The Eurogroup was suspended inconclusively after only one hour. Instead, a new meeting with Commission President Juncker, Greek Prime Minster Tsipras, Christine Lagarde from the IMF, ECB president Mario Draghi, Eurogroup president Dijsselbloem and ESM chairman Regling was held at midnight. Again inconclusive. All of this provides little evidence to become more optimistic about a positive outcome of the Greek negotiations. Today, the meeting marathon will continue with technical meetings of senior officials already this morning, at 6am, another meeting at the political level at 9am, another Eurogroup meeting scheduled for 1pm and then later at 4pm the European summit. Obviously and technically speaking, this meeting marathon could continue for many days (even weeks), European leaders will still be in Brussels tomorrow and a deal could even be signed off in the weekend. However, it is hard to see that all parties involved in the negotiations have the energy and will to continue much longer. Trying to separate facts from noise, the substantial differences between Greece and the Eurozone creditors mainly concentrate on three main areas: taxes, pensions and debt relief. While there seems to be a general agreement on the headline targets for the primary balance, there are still huge discrepancies on how to get there. It looks as if currently the main hurdle seems to be taxes. Instead of cutting public expenditures, the Greek government proposed to increase taxes and strengthen revenues. For a country not really known for a good track record in tax collections, this looks like a risky strategy. The creditors proposed to trim the Greek proposal of an increase in the corporate tax rate and reject the introduction of a one-off corporate tax on corporate profits. The more controversial area seems that of pension reforms. The institutions clearly want Greece to accelerate the transition towards a broad-based implementation of the limit of the statutory retirement age of 67 years, requesting that to happen by 2022, and not by 2026, as in the last Greek proposal. Also, the counterproposal asks to raise health contributions and to harmonize the contribution rules for all pension funds, seeking a closer link between contribution and benefit. Finally, the never-ending issue of debt relief is probably the biggest stumbling block. The Greeks want it, the others don’t want to give it (or eventually only at the end of a long reform ride). Looking at the substance of the differences between Greece and its creditors, a compromise still looks possible; at least in our view. The two crucial questions are how to deal with the issue of debt relief and how to eventually sell any compromise back at home. The latest comments from the Greek parliament suggest that selling at home might still be a challenge for Tsipras. Still, even if a compromise could be feasible, the series of latest events sends contrary signals and does little to soften atmospherical disturbances. In fact, it seems as if the entire Greek crisis has switched into warp speed. There are now as many contradictory statements, denials, inconclusive meetings and ad hoc special meetings on a single day as there were before within a week or a month. In our view a clear sign that the excessively used words of “final showdown” can again be used with a good heart.

European Court backs ECB

The ECB’s Outright Monetary Transactions (OMT) programme was legal. The European Court of Justice (ECJ) just released its ruling on the OMT, calling it compatible with EU law. Even if widely expected, this ruling still brings a relief at the ECB and in financial markets. However, at least the press release still leaves the door open for new lawsuits against QE. Remember that OMT was the programme the ECB announced back in 2012 when the risk of a Eurozone break-up had increased significantly. It was the incarnation of Mario Draghi’s famous ”whatever-it-takes” speech in July 2012. Back then, the speech and the subsequent announcement of OMT calmed financial markets and spreads on government bond yields narrowed again, assuming that the ECB had finally accepted a role as the lender of last resort. The ECB, however, has never referred to the role of lender of last resort but has always argued that OMT was a sheer monetary policy instrument, targeted at a proper functioning of the monetary transmission mechanism. While markets were cheerful, some Germans were not and started a law suit against the ECB, putting the OMT’s legality into question. With OMT, this was the argumentation, the ECB had crossed the Rubicon, entered the arena of monetary financing and had put German taxpayers (without any accountability) at risk. The lawsuit was filed at the German Constitutional Court. Then, in early 2014, the German Constitutional Court has basically said that it was unable to assess the legality of the ECB’s OMT but if it could, it would deem it illegal. This is why the German judges had referred the case to the ECJ. The ruling The ECJ just released a first four-pager press release with the main argumentation of the ruling. The entire verdict will be released later today. Judging from the press release, the ECJ gives the clear backing to the ECB. According to the ruling, the OMT programme “falls within monetary policy and therefore within the powers of the ESCB”. OMT contributes to the singleness of monetary policy. The ECB’s role in the Troika Today’s positive ruling does not come as a surprise. In fact, the ECJ broadly followed the advice of its Advocate-General Cruz Villalon. This advice was given back in January this year. However, the Advocate-General had pointed out another issue, which is of great interest. In the event of the OMT programme being implemented, the “ECB must refrain from any direct involvement in the financial assistance programme that applies to the State concerned”. Back then a clear sign that the ECB’s role in the Troika should be revisited. Today’s official ECJ ruling – at least in the press release – does not comment on this aspect anymore. Impact on QE There is no doubt that OMT paved the way for QE, even if there are some substantial differences between the two. While OMT has a built-in conditionality and only focusses on the countries applying for OMT, QE is unconditional and purchases are spread across Eurozone countries. Today’s ruling should clearly discourage new lawsuits against QE, though not entirely. The ECJ states that ECB bond purchases could in practice have an effect “equivalent to that of a direct purchase”, particularly when potential purchasers of government bonds in the primary market new for sure that the ECB was buying in the secondary market. In our view, the ECJ kept the door to new QE lawsuits slightly open. Who has the last word? Anyone familiar with lawsuits knows that there is almost always the possibility to continue. This is why even the discussion on OMT might now be entirely over and solved. After today’s ruling, the crucial question is whether the German Constitutional Court will simply embrace the ECJ’s ruling or not. In 2014, the German Constitutional Court clearly signaled its own judgement, namely that the OMT may well exceed the mandate given to the ECB and would be inconsistent with the prohibition of monetary financing of member states. Even if the European Court would rule favorably towards the ECB, the German Constitutional Court made it clear that it reserves its own judgement and that it would not automatically follow the ECJ’s opinion. In its own view, the German Constitutional Court claims to have the last word in extreme cases. However, even if in theory the German Court could still come with a different ruling, it is hard to see that this would really happen in reality. It would lead to a legal conflict between two strong Courts with reputational damage for all. In sum All in all, today’s ECJ ruling should bring some relief to markets. In these times, when Eurozone policymakers are realizing that a Grexit would lead to contagion on financial markets, at least in the short run, confirming and strengthening the ECB’s OMT is almost existential. Up to now, OMT has been the ECB’s most powerful tool, and actually the most powerful tool which did not cost a single euro. The ECJ gave a strong backing to the ECB’s independence and sent a sad message to some Germans: there is European life outside the German borders.

ECB meeting - Taper tempering

As expected, the ECB did not announce any new policy measures at today’s meeting. While generally speaking, today’s meeting was one of those meetings which do not necessarily require a press conference, ECB president Draghi sent two main messages: the fragile start of a cyclical recovery does not justify any tapering speculations, and, the ECB will not pull the trigger on Greece. The ECB’s macro-economic assessment remained cheerful and almost self-congratulating. The tone on the recovery has become somewhat more positive and risks to the outlook for growth were for the first time in a long while described as “more balanced”, though still at the downside. The ECB staff projections remained virtually unchanged compared with the March projections, forecasting GDP growth in the Eurozone to come in at 1.5% this year, 1.9% next year and 2.0% in 2017. The positive tone was only slightly offset by Draghi’s remarks that the recovery had lost some momentum in the second quarter, which explained why the ECB currently only expected the recovery to “broaden” but no longer to “strengthen”. Cruising along. Interestingly, the ECB takes lots of comfort from stronger domestic demand. In our view, continued deleveraging and still high unemployment make banking on domestic demand as a sustainable growth driver a risky strategy. As regards inflation, the slight uptick of oil prices has pushed up inflation projections for this year to 0.3%. For 2016 and 2017, inflation projections remained unchanged at 1.5% and 1.8% respectively. The ECB’s current economic and inflation outlook could give rise to speculations about an earlier-than-expected end of QE. To tackle any of these speculations, Draghi emphasized several times today that the ECB’s macro-economic outlook was conditional on the full implementation of QE. Moreover, there were three even stronger signals from Draghi that any tapering discussions were premature: 1) the cross-checking part of the introductory statement included a new sentence reading that “…confirms the need to maintain a steady monetary policy course, firmly implementing the Governing Council’s monetary policy decisions”; 2) Draghi said that even if the inflation projections were close to the ECB’s definition of price stability, the ECB was nowhere near fulfilling its target and could even add to the monthly purchases; and 3) any exit strategy was a “high class problem” and not yet discussed by the ECB. Even possible bubbles or misallocations in financial markets were no reason for the ECB to adjust QE. Draghi clearly stated that any possible negative effects from QE had to be tackled by supervisors but not by monetary policy. However, despite trying to temper tapering speculations, Draghi is still struggling to give clear guidance. The question on whether QE could be ended before end-September 2016 if inflation expectations are back at where the ECB wants them before, was unanswered. The story of the hour (or better: days, weeks, months and years), is clearly Greece. Earlier today, some details of the latest – some even call it the last – take-it-or-leave-it offer from Greece’s Eurozone creditors had surfaced. According to media reports, the Eurozone would be willing to adjust Greece’s fiscal targets for the coming years. Instead of a permanent primary surplus target of 4.5% starting next year, Greece would be allowed a softer path, gradually tightening austerity screws from a surplus of 1% this year to 3.5% in 2018. However, it is unclear how the Eurozone creditors want to stick to the same debt targets without debt restructuring when fiscal targets are softened and growth has been weaker. Here, Draghi – who initially didn’t want to comment on Greece at all – said that the ECB wanted Greece to be in the Eurozone but that there was a need for “a strong agreement”. Greece was a viable economy if the right policies were implemented. The ECB was in favour of a strong agreement which provided social fairness and economic growth but also fiscal sustainability and financial stability. Answering to questions on ELA and possible additional haircuts on Greek bonds, Draghi remarked that the ECB would stick to its rules-based approach and the different rules applied to ELA and the ECB’s collateral rules. It is obvious that the ECB will not pull the trigger on Greece autonomously. As long as there is the political will from all sides to find a sustainable agreement, the ECB will continue with its current ELA and liquidity stance. All in all, today’s press conference showed that the ECB is aware of the upcoming tapering speculations and clearly wants to temper them. However, more forward guidance and communication streamlining will be needed in the months to keep speculations at bay. Carsten Brzeski

ECB meeting - Unexpected excitment in Frankfurt

What everyone had expected to be a rather dull press conference will go down in history as an unforgettable meeting. Not so much due to new monetary policy action or insights but due to a female protester storming on top of ECB president Draghi’s desk, spraying confetti on him and shouting about the end of “ECB dictatorship”. Luckily, no one was harmed and the woman was quickly hauled away. A stalwart Draghi continued with the press conference just a few minutes later. The rest of the press conference could hardly match the excitement of the first minutes. As expected, the ECB kept interest rates unchanged. While the ECB’s macro assessment was somewhat more positive than at the ECB’s March meeting, not a lot has changed. Draghi’s main goal today was obviously to downplay any premature tapering speculations. And, he accomplished his mission. At least for now. As regards the ECB’s macro-economic assessment, Draghi stressed the prospects for a Eurozone recovery on the back of improved domestic demand, lower oil prices, the weaker euro and also structural reforms. Draghi also pointed to still existing risks to the recovery but the most notable change in the assessment was a slight change to the risk assessment. According to the ECB, risks to the outlook are still to the downside but now “more balanced” than in March. As regards inflation, the ECB kept the same assessment as in March, which is a very gradual increase in headline inflation over the next two years. More specifically on QE, Draghi repeated that monetary policy alone could not carry the economic recovery. Governments needed to continue with structural reforms. Addressing earlier criticism, Draghi said that QE did not prevent governments from implementing reforms but was rather conducive for reforms. Asked about possible side-effects from QE, Draghi acknowledged that a protracted period of low interest rates could lead to imbalances but he did not yet see any bubbles in the Eurozone. With many government bond yields currently trading in negative territory, we indeed are curious to learn more about Draghi’s definition of bubbles. In the days leading to today’s meeting, some market participants had started to discuss the possibility of an early tapering, an end of QE earlier than the officially intended deadline of September 2016. One reason for this discussion is actually the success of QE which has pushed down the euro exchange rate. At its current level, the weak euro would mechanically add another 0.4%-points to inflation, bringing headline inflation above 2% in 2017. This could already happen at the June meeting, when the ECB will present the next staff projections. During the press conference, Draghi tried everything he could to temper the taper discussion. According to Draghi, the tapering discussion was premature. And we totally agree with him. Draghi did not get tired of repeating that the full implementation of QE was required to “provide the necessary support to the euro area recovery”. Moreover, a new sentence in the ECB’s introductory statement clearly tried to temper tapering phantasies: “When carrying out its assessment, the Governing Council will follow its monetary policy strategy and concentrate on trends in inflation, looking through unexpected outcomes in measured inflation in either direction if judged to be transient and to have no implication for the medium-term outlook for price stability” In our view, this sentence is just ECB language for saying that the ECB can do whatever it wants and use whatever indicator it wants to use to determine the end of QE. All in all, ECB president Draghi clearly tried to temper any taper discussion. Whether he will succeed, is uncertain. If the recovery really unfolds and inflation forecasts start to pick up, Draghi will not only have to temper taper speculations in the market but, even more challenging, within the ECB itself.

Good news show from Nikosia

As expected, the ECB today kept interest rates unchanged at its meeting in Cyprus. While Draghi was surprisingly upbeat on the economic outlook and the impact of QE, he kept a stringent stance on Greece. The ECB’s macro-economic assessment sounded as if the ECB is a bit inebriated by its own QE announcement. It was the most positive and optimistic assessment in a long while. Words like “broadening” and “strengthening” had not been used in combination with the Eurozone recovery for quite a while. In more detail, the ECB emphasized a “significant number of positive effects” from latest monetary policy decisions, as for example improved financial market conditions, financing conditions and lower borrowing costs. Moreover, the ECB stressed the fact that confidence indicators had also improved recently. Finally, lower energy prices and the weaker euro exchange rate should also contribute to the Eurozone recovery. This more positive take on the Eurozone economy was also reflected in the latest ECB staff projections which foresee GDP growth coming in at 1.5% in 2015 (from 1.0% at the December projections), 1.9% in 2016 (from 1.5) and 2.1% in 2017. It was for the first time since 2007 that the ECB projects a single year with GDP growth above 2%. With regards to inflation, ECB staff revised downwards its projections for this year due to lower actual inflation rates. More generally speaking, the ECB expects a very gradual increase of inflation over the coming years. In detail, ECB staff projections now foresee headline inflation to come in at 0% this year (from 0.7%), 1.5% in 2016 (from 1.3%) and 1.8% in 2017. To be fair, Draghi said that the ECB’s staff projections were conditional of a full implementation of all announced monetary policy measures. Don’t even dare thinking about tapering before QE has actually started. As for QE, Draghi revealed some interesting details. The ECB will start the actual government bond purchases next week Monday. Draghi repeated the January wording that the ECB will buy 60bn euro per month until the end of September 2016 and, in any case, until the ECB sees “a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2%”. The latter gives the ECB a lot discretionary power to alter the programme if need be. Draghi explicitly said that the ECB would buy government bonds with negative yields only if yield are not lower than the deposit rate. This would currently only exclude 2 year German government bonds. During the press conference, there were also several questions on Greece, QE and ELA. The bottom line of Draghi’s answers was that the ECB would only buy government bonds rated lower than investment grade if the countries are in a bailout programme and the programme is not in a review period. Moreover, the ECB could not buy more than 33% of a single issuer. For Greece, all of this means that the ECB could at the earliest start purchasing Greek bonds only in June or July, if and when Greece has reimbursed the bond expiring in June which the ECB had (partly) purchased under the old SMP programme. Finally, Draghi also said that ELA for Greek banks had been extended by 500 million euro. The ECB’s stance on Greece has definitely not softened. Overall, the ECB’s macro-economic assessment was much more upbeat than in previous months. It looks as if at least the ECB is a strong believer in the positive economic impact of its own QE programme. Admittedly, it would have been difficult for the ECB not to be positive but today’s euphoria was in our view almost a bit overdone. The warning that the more positive outlook should not lead to complacency and that now governments had to “contribute decisively” to the recovery was a standard part of the ECB’s introductory statement. However, it remains to be seen how credible this call on governments will be if at the same time the ECB will make an enormous advance payment in the form of its QE. To some extent this has some similarities with parents cleaning up their children's room and then asking them to do something as well. A strategy that might not make it into bestselling parenting guidebooks.

Mario Draghi's latest (and last) stunt?

Today, the ECB finally entered the global QE arena. Instead of keeping some aces up their sleeves, the ECB showed its entire hand: a fully-fledged QE programme with exact numbers; a €1.1 trillion quantitative easing programme to boost the economy. At least when it comes to the precision and details already presented today, the programme is bolder than expected. The arguments supporting the QE decision have been known already for a long while. Low inflation expectations, negative inflation rates, disappointing results from earlier liquidity and credit-enhancing measures and an overall bleak outlook for growth are convincing arguments for the ECB to act again. According to the ECB today, additional asset purchases are needed to counter two unfavourable developments: weaker-than-expected inflation dynamics and heightened risks of a too prolonged period of low inflation. As regards the details, the ECB announced to expand the current asset purchase programme (of ABS and covered bonds) by including government bonds. For the first time, the ECB also presented a monthly target for its purchases. As of March, the ECB will start purchasing “euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary markets”. Or in short, government bonds and supranational bonds. The ECB’s purchases will be based on the national central banks’ shares in the ECB’s capital key and the ECB plans to buy government bonds with maturities between two and 30 years. However, according to Draghi, the ECB purchases will be limited to 33% of each issuer. The statement that “some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme” means that the ECB could also by Greek bonds, at least as long Greece stays in a bailout programme. Moreover, the ECB also announced to scrap the 10 basis point premium on all six remaining TLTROs. With the amount of 60bn euro per month and the intended duration of the programme until the end of September 2016, the ECB could return the size of its balance sheet back to 3 trillion euro. Given the amount of purchased ABS and covered bonds so far, the ECB will indeed have to buy government bonds for at least around 50bn euro. Despite the hard numbers, the ECB’s commitment was at least semi open-ended as Draghi also said that QE would also continue "at least until we see a sustained adjustment to the path of inflation". According to Draghi, the issue of risk-sharing of the purchases was not essential for the effectiveness of monetary policy. Nevertheless, the ECB had to accommodate concerns of some national central banks. As a consequence, only 20% of the purchases will be risk-shared (of which the main part would be supranational bonds), the rest not. The impact of QE in the Eurozone is highly controversial. If there is at least one single inflationary tendency in the Eurozone right now, it is the amount of articles and opinions on the sense and nonsense of QE. Only time will tell which arguments were right or wrong. Obviously, the ECB hopes for an investment boom on the back of QE and even lower interest rates. However, whether ECB purchases of government bonds will really free new lending space at banks or through higher equity prices room for corporate investment is far from certain. Therefore, the safest bet for a positive QE impact seems to be through a weaker euro exchange rate. All in all, it seems that the ECB hopes for a happy end of a long fairy tale of fighting the euro crisis. It all started with measures to keep the Eurozone together and has now led to a series of activity –reviving measures (just think of negative deposit rates, TLTROs, ABS and covered bond purchases). There is no guarantee that QE will work. The ECB can prepare the grounds for more investment and activity but it cannot force consumers to spend or companies to invest. This also requires further structural reforms, fiscal support and probably a longer, positive, vision for the entire Eurozone. Against this background, today’s QE announcement is historic but it was also the ECB’s last trump card. There are no more hidden aces. We have heard it often in the past but the flowery phrase that the ball is now back in the court of Eurozone governments has never been more true than today. Even worse, the ECB will not be able to pick it up again if governments try to play it back.

Draghi’s oil front against QE-opponents

Despite no action at today’s ECB meeting, president Draghi sent strong signals that QE will start next year. The inflationary number of Draghi using the word “QE” was probably the broadest hint he could give. The ECB’s macro-economic assessment has become grimmer. Particularly, the ECB’s view on growth looks much more pessimistic than three months ago. In its latest projections, ECB staff now expects GDP growth to come in at 1.0% in 2015 and 1.5% in 2016. Back in September, this was still 1.6% and 1.9%. The revision to the 2015 forecasts are probably the sharpest downward revisions within one quarter ever. Interestingly, the narrative behind these growth forecasts has not changed. The ECB still believes in a modest economic recovery on the back of domestic demand and the global recovery. Risks, however, remain to the downside. As regards inflation, the ECB sounded more alarmed. The fact that staff projections had been revised downwards seems to be the main cause for the following QE-signals. ECB staff now expects inflation to come in at 0.7% in 2015 and 1.3% in 2016, from 1.1% and 1.5% respectively in the September forecasts. These revisions reflect mainly lower oil prices in euro terms and the impact of the downwardly revised outlook for growth During the press conference, Draghi repeatedly used the lower inflation forecasts and the fact that energy prices had dropped further in the last two weeks as the main reason for concerns. In our view, the importance oil prices have received in the ECB’s current monetary policy discussions is a bit unclear. In earlier times, the ECB would have tended to ignore short-term effects from oil price fluctuations on headline inflation. Now, it seems as if Draghi is using oil as an argument to convince the last QE-opponents. However, it is remarkable that Draghi was relatively muted on the positive impact from lower energy prices on oil. Earlier this week, for example, IMF chief Lagarde had said that the current drop in oil prices could add 0.8% on growth in most advanced economies. The scene is clearly set for QE. Draghi’s comments during the Q&A could hardly leave any doubt: the ECB is determined to start some kind of QE in 2015. Here are the key sentences: According to Draghi, the ECB will “reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.” Moreover, the slight change in tone that the ECB now “intended” and no longer “expected” the current measures to reach the size of the balance sheet from 2012 was the last evidence of the ECB’s determination. So, where does all of this leave us now? Here are the facts: the ECB will discuss QE in the first quarter of next year. In our view, this will not yet take place in January as too few new information will be available by then. As regards the balance sheet, we will get the second TLTRO on 11 December. Then, the run-off of the two earlier 3-year LTROs (accounting for roughly 280bn euro) could in the short run even reduce excess liquidity in the Eurozone. Moreover, the March TLTRO will be the first one where the take-up is depending on net lending and not the loan stock. Add to this the next staff projections and the ECB should have all information needed to go all the way. This makes us comfortable to stick to our current forecast of (an announcement of) a first intermediate QE in the first quarter, followed by sovereign QE in the second quarter, unless the Eurozone economy stages an unexpected growth revival. Obviously, not all ECB members, not even all members of the ECB’s Executive Board, are fully supportive on the role of the balance sheet in the ECB’s decision-making. However, the continued emphasizing of low inflation will make it very hard for even the purest Germanic monetarists to eventually block QE.

German inflation drops in November

Based on the results of six regional states, German headline inflation dropped to 0.6% YoY in November, from 0.8% in October. On the month, German prices remained unchanged. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation decreased to 0.5%, from 0.7% in October, and stands now at its lowest level since February 2010. A quick look at the available components at the regional levels shows that the drop in headline inflation was not only driven by lower energy prices but also some tentative second-round effects on consumer goods and a drop in prices for vacation destinations and package tours. Looking ahead, the recent drop in energy prices – if sustained and if not offset by strong currency weakening – could push German headline inflation further down. Corrected for the euro depreciation vis-à-vis the US dollar, oil prices have dropped by more than 15% since last November. Not all of this price drop has yet been passed through to consumer prices. However, as German employment just reached another record-high in October, this drop in inflation should be inflationary rather than deflationary. Just think of Draghi’s famous words “with low inflation, you can buy more stuff”. At the current juncture, price expectations of both consumers and producers remain solidly anchored in Germany. According to today’s economic sentiment indicators from the European Commission, price expectations by both consumer and producers have slightly come down in November but remain close to their respective historical averages. Interestingly, price expectations in the service sector have now increased for three months in a row and are close to all-time highs. This might be the result of higher wages and maybe also the introduction of the minimum wage. For next week’s ECB meeting, today’s German inflation data could be the prelude of another downward revision of the ECB’s inflation forecasts. Back in September, ECB staff had projected an average inflation rate of 1.1% for 2015 and 1.4% for 2016. Even without any significant changes to the growth outlook, the latest drop in energy prices should be sufficient to automatically lead to lower inflation forecasts. Remember that last month, ECB president Draghi had described two “contingencies” for further action: the current measures are not enough to reach the new (soft) balance sheet target, and a worsening of the medium-term outlook for inflation. Obviously, next week will be too early to give an assessment on the first contingency but with lower inflation projections, one of the two lights needed to start QE could already be lit green next week.

ECB shows some of the money

More questions than answers? At its meeting in Naples, the ECB unsurprisingly decided to keep interest rates unchanged. Moreover, the ECB presented some details of the already announced ABS and covered bond purchasing programmes. ECB president Draghi’s comments at the press conference have increased rather than decreased the likelihood of more action to come. The ECB’s assessment of the Eurozone economy remained unchanged and was almost a verbatim copy of the September assessment. The entire macro-assessment can nicely be summarized with Draghi’s own word: “I have always said that the recovery is weak, fragile and uneven”. Nothing to add here. In ECB language this means that risks to growth remain to the downside. As in September, the ECB stopped giving a direction for risks to the inflation outlook. As regards the ECB’s asset-backed securities purchase programme (ABSPP) and covered bond purchase programme (CBPP3), the ECB presented some technical details after the press conference. The ECB’s purchasing programmes will start in mid-October (covered bonds) and the fourth quarter (ABS) and will run for two years. The details of the ABS programme are limited to purchases of senior tranches and follow more or less the current principles or guidelines of the ECB’s collateral policies. The ECB decided to also accept assets from Greece and Cyprus, but only under certain caveats and additional conditions. In the press conference, Draghi suggested that the ECB would only accept assets from these two countries if they were running under (EU) programmes. This, however, was not reflected in the published texts. Consequently, this could clearly hinder the Greek government’s latest attempts to exit the second bailout programme without a follow-up. The most important issue of the ABS purchasing programme, however, remains unanswered. The controversy about the riskier ABS tranches has apparently not been solved, yet. Remember that several Eurozone governments, particularly France and Germany, had already given the ECB the cold shoulder, refusing to guarantee mezzanine tranches. However, without purchases of the riskier ABS tranches, the programmes will be handicapped before they start. In the official text, the ECB only said that details of purchases of mezzanine tranches will be published at a later stage. In general, the ECB refrained from answering two important questions on the ABS and covered bond purchasing programmes: will there be a country distribution and what will be the total volume? Regarding the volume of all purchases, Draghi made the latest new soft target, the size of the balance sheet, a bit softer. He said that the “potential universe” of all eligible ABS and covered bonds was 1 trillion euro. On top of that come the TLTROs. Returning the ECB’s balance sheet to its size of 2012 (which would require an increase of 1000 billion euro) was an instrument rather than a goal. The ECB obviously sticks to its current strategy of repairing the transmission channel of monetary policy. All measures are aimed at supporting the supply side of the credit economy, ie banks. At several occasions during the press conference, Draghi stressed that monetary policy alone could not restore growth in the Eurozone. He called several times for more (implementation of) structural reforms, the use of fiscal room for manoeuvre and demand-side policies. Whether this was another invitation for Eurozone governments to join another grand bargain, or just another desperate cry in the dark remains to be seen. The experience of the last years, however, tells us that the ECB’s advance payments have hardly ever been matched by equivalent government actions. In this context, the fact that Draghi mentioned the ECB’s unanimous commitment “to using additional unconventional instruments” three times compared with only one time last month is in our view a clear signal that the ECB is determined to do more and even bolder action if necessary.