Mario Draghi's pudding

At today’s meeting, the ECB kept interest rates on hold and presented details of its new bond buying programme. Mario Draghi truly presented his “believe me it is enough”. Now the ball is back with Eurozone governments.


The ECB’s macro-economic assessment was clearly not top priority of today’s meeting. The ECB’s staff projections have hardly received so little attention as today. In its macro-economic assessment, the ECB acknowledged a further deterioration of the economic situation in the Eurozone. In the latest ECB staff projections, GDP growth forecasts for both this and next year were revised downwards. ECB staff now expected GDP growth to come in at -0.4% (from -0.1% in June) and 0.5% (from 1%) for next year. As regards inflation, the projections were revised slightly upwards to 2.5% (from 2.4%) for this year and 1.9% (from 1.6%) for next year. As the economic assessment might still be too positive, a rate cut in the coming months looks still possible.

All eyes were focussed on the ECB’s possible plan for bond purchases. By keeping interest rates unchanged, the pressure to at least deliver on the plan had increased even further. And, indeed, ECB president Draghi delivered the new ECB bazooka: the so-called OMT (outright monetary transactions) programme.

With the start of the OMT, the old SMP will be officially put to an end. According to the ECB, the new OMT is aimed at “safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”. A clear attempt to present it as a pure monetary policy tool and not as a way to finance governments in need. As expected, the OMT will be conditional on an EFSF/ESM programme. According to the ECB, such a programme does not necessarily have to be a fully-fledged bailout package but could also be a precautionary programme. As the ECB said “involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme”. In our view, all of this means that the ECB will only activate its OMT programme if a country in question has agreed on a so-called Memorandum of Understanding with the Troika and if EFSF/ESM engages in purchases in the primary market. The OMT will be focused on the short end of the yield curve on, in particular, sovereign bonds with a maturity of between one and three years. The OMT will not only be applied to future bailout candidates but could already be started for Eurozone countries currently under a macroeconomic adjustment programme once they start to regain bond market access (which seems to be a rather stringent condition in our view).

Bond purchases under the OMT programme will be sterilised and the ECB will not take a senior status on its holdings. When and how the ECB plans to intervene, however, was not disclosed. It seems as if there will not be any explicit targets. The ECB only plans to announce its purchases ex post on a weekly and monthly basis. In addition to the OMT programme, the ECB also announced that it will accept government bonds as collaterals independent of their credit ratings (except for Greek bonds).

All in all, the ECB has presented a big new bazooka which should help buying time. This is probably he furthest the ECB can go to help governments. The focus on the monetary policy transmission and strict conditionality should also calm the Bundesbank temper, even if they would not admit it. However, the emphasis on the transmission mechanism is also a danger as it still contains a logical contradiction. With the OMT, the ECB will only repair the transmission mechanism in countries with ask for EFSF/ESM. But what about the other countries? It remains a bit strange. For the time being, one thing is clear: never underestimate Mario Draghi. He clearly delivered on his “believe me it will be enough” announcement. A man, a word. But as he said himself: “the proof is in the pudding”.

ECB preview - Waiting for ground-breaking action

This week could be the most groundbreaking one in the ECB’s history. When the ECB meets on Thursday, it will discuss the details of its new bond-purchasing programme. For some, the new plan marks the final end of the Bundesbank doctrine; for others, it is a necessary evil to calm the crisis. It is obvious to us that Mario Draghi’s congeniality and some vague words alone will not have the same calming effect as in August. In our view, the ECB might eventually present targets for short-term bond yields linked to the refi rate. However, not all the detail might be revealed this week, perhaps because there is not yet full agreement within the Governing Council, but maybe also to keep pressure on peripheral governments.

Recession feeling increases. Anything else than a downward revision of the ECB staff projections would come as a surprise. Although second-quarter growth was slightly less dramatic than expected, thanks to strong German growth, all confidence indicators point to a further worsening of the economic situation. The best expectation for an end to the recessionary feeling is currently for the end of the year. A downward revision of the ECB staff’s growth projections could be a good justification for a rate cut at this week’s meeting. However, in our view, a rate cut would only become a policy option if the Governing Council cannot find an agreement on the new bond purchasing – a kind of sweetener.

All eyes on bond-buying plan. A further deterioration of the economic outlook should not be the main topic of this week’s meeting. All eyes are on the much-awaited plan for ECB bond purchases, an SMP 2.0. Two things seem certain: first, any ECB bond purchasing will be conditional on a country applying for an EFSF/ESM programme. Preferably, the ECB would even like to see the EFSF/ESM purchase bonds in the primary markets before it gets active in the secondary market itself. Second, the ECB will purchase only short-term bonds. For the rest, however, it remains almost anybody’s best guess what Draghi will present on Thursday.

How could it look like? In our view, the ECB will eventually present explicit targets for short-term bond yields (probably up to three years) under an SMP 2.0. Of course, explicit targets contain the risk of inviting speculative attacks. However, implicit or secret targets are harder to defend in a credible fashion. To avoid the issue of setting “neutral” levels for bond spreads and to stress the fact that SMP 2.0 is mainly targeted at the transmission of monetary policy, the ECB could actually link targets for short-term bond yields to the refi rate and not another benchmark bond.

High risks, and devil remains in the detail. Obviously, there are still many potential risks and unsolved issues in any new ECB bond purchases. In particular, the issue of conditionality should be more of a concern to the ECB than future inflation risks. Will the ECB implicitly put its destiny in the hands of the Troika, making bond purchases exclusively dependent on an EFSF/ESM programme? Moreover, issues of whether or not to sterilise also seem tricky, given the potential size of the new plan. Obviously, the new bond purchasing plan will bring the ECB into uncharted and dangerous territory. However, we believe that with the August announcements the ECB has already passed the point of no return.

Letter from Brussels - Bruesseler Baustellen

Als Deutscher in Brüssel hat man es nicht einfach. Nicht nur, dass europäische Nachbarn einen ständig als Euro-Rettungsverweigerer beschimpfen, nur weil man nicht einsieht, dass deutsches Steuergeld ohne Gegenleistung in andere Länder gepumpt wird. Nein, auch weil man sich als deutscher mit Hang zur Ordnungsliebe gerne am Brüsseler Alltag stört. Die Straße vor meiner Haustür wurde dieses Jahr nun schon zehn Mal ausgebuddelt, zugeschüttet und wieder geöffnet. Jedes Mal für einen anderen Zweck. Fragen des „Wieso, weshalb, warums“ werden in Brüssel nur mit Kopfschütteln begegnet. Das ist nun mal so. Eine unübersichtliche, scheinbar chaotische Strategie ohne deutliches Ziel? Das gibt es nicht nur im Brüsseler Straßenbau.

Ähnlich wie in meiner Brüsseler Straße werden auch in der Euro-Krise regelmäßig neue Baustellen geöffnet, geschlossen und wieder geöffnet. Teilweise aber auch ganz und gar vergessen. Manche Wundermittel sind schon wieder in Vergessenheit geraten bevor sie jemals umgesetzt wurden. Andere Maßnahmen werden gerne als alternativlos dargestellt, auch wenn sie nationale Volksvertreter und Bürger mit astronomisch hohen Beträgen konfrontieren. Da überrascht es nicht, wenn viele Menschen mittlerweile krisenmüde geworden sind und sich in populistisch einfache Aussagen wie „Griechenland rein oder raus“ flüchten.

Um den zunehmenden Populismus in der Euro-Krise zu bekämpfen, ist mehr Aufklärungsarbeit gefragt. In den nächsten Wochen wird innerhalb kürzester Zeit über Rettungsschirme, Griechenland und Staatsanleihenkäufe der EZB entschieden wird. Gleichzeitig kursieren Pläne zur Bankenunion und mehr Integration. Das sind viele Baustellen zur gleichen Zeit. Will man nicht das Kopfschütteln der europäischen Buerger ernten, wird es Zeit zu erklären, wie die verschiedenen Baustellen zueinander passen und wie die Strasse irgendwann mal aussehen soll.


Dieser "Letter from Brussels" erschien in der Euro am Sonntag.

German labour market worsens in small steps

German unemployment increased by a non-seasonally adjusted 29,100 in August, bringing the number of unemployment to the highest since April this year. Currently, 2.905 million people are without a job. This is less than in August 2011. The most alarming signal from today’s report is the fact that the non-seasonally adjusted monthly increase is the highest August increase since 1993. A clear signal that the best times of the German labour market are over. In seasonally-adjusted terms, unemployment increased slightly, leaving the seasonally-adjusted unemployment rate unchanged at 6.8%.


The strong labour market has been one of the main drivers of German growth in the first half of the year. Low unemployment, record high employment and wage increases supported private consumption and helped cushioning the industrial slowdown. Looking ahead, however, it is doubtful whether private consumption can really take over the baton as main growth driver for the German economy. Today’s numbers provide further evidence that the labour market is gradually losing steam and that the positive impact on the economy should peter out towards the end of the year. Employment expectations in the manufacturing sector have entered negative territory, most open vacancies are temporary jobs and several companies have reintroduced short-time work schemes. Obviously not the best climate for a new round of wage increases, consequently boding ill for private consumption..

The ongoing demographic change should keep a lid on any increase in German unemployment rates in the near future. However, it is hard to deny that the resilience of the German labour market is cracking up.

Ifo continues downward slide

The downward slide continues as German companies are increasingly becoming pessimistic about the future. The Ifo index continued its recent downward trend in August, dropping to 102.3, from 103.3 in July. This is the fourth consecutive drop, bringing the Ifo index to its lowest level since March 2010. With a sharp drop to 94.2, from 95.6 in July, the expectation component has now reached levels which in the past corresponded with recessions. The only upside in today’s Ifo report is that the drop in the current assessment component remained rather modest (to 111.2, from 111.6).


Exports and domestic consumption have shielded the German economy against the euro crisis virus up to now. This immunity, however, has been crumbling away quickly over recent months. The sharp drop in new orders from other Eurozone countries since the beginning of the year and continued inventory reductions have weakened the German industry. Moreover, as several companies have again started to introduce short-time work schemes support from the labour market should also diminish in the coming months. As a consequence, it looks as if the German economy will, at best, be treading water in the coming months. The latest batch of sentiment indicators even points to a contraction in the third quarter. However, let’s be clear, given the sound fundamentals of the economy, any contraction should hardly feel recessionary in Germany.

The still solid current assessment component of today’s Ifo report illustrates the relative strength of the economy. However, the headline figure and, above all, downbeat expectations clearly add to concerns that strong growth in the first half of the year was just the last flaring up of the new German Wirtschaftswunder.

Solid German growth confirmed - curse or blessing for Merkel?

Solid growth confirmed. The second estimate of the statistical office confirmed that the German economy defied the euro crisis in the first half of the year. GDP growth in the Eurozone’s biggest economy came in at 0.3% QoQ in the second quarter, from 0.5% in 1Q 2012. Growth was driven net exports, with exports up by 2.5% QoQ, government (0.2% QoQ) and private consumption (0.4%). Investments were down by 1.8% QoQ. German growth remains well-balanced but signs of waning strength are increasing.

Looking ahead, however, there is a risk that the strong performance in the first half of the year was the last flaring up of the new German Wirtschaftswunder. The sharp drop in new orders from other Eurozone countries since the beginning of the year shows that the euro crisis has already reached the German economy. The safety net of richly filled order books and low inventories has become thinner very rapidly, not boding well for growth in the second half of the year. At the same time, low interest rates and wage increases should support domestic investment and consumption, partly offsetting the negative impact from weakening external demand. However, solid domestic demand can only cushion the slowdown of the economy but will not transform Germany into an economic island.

For German chancellor Merkel, today’s growth numbers are not as comfortable as they might look as they complicate next steps in the euro crisis. To some extent, today’s numbers are both a blessing and a curse. German growth is still too strong to convince coalition partners and also the public opinion of waning crisis immunity. However, at the same time, growth is too weak to seriously label the German economy invincible. As a consequence, chancellor Merkel looks likely to continue with her gradual strategy toward conditional integration. When Merkel meets with French president Hollande today and Greek president Samaras tomorrow, no clear decisions should be expected. Even Samaras’ latest “you-get-your-money-back” initiative in German newspapers will not (yet) do the trick. Given latest comments, chancellor Merkel seems not entirely reluctant to give Greece more time but only if it does not cost more money. In our view, however, any significant German move will only come after the next Troika report and, of course, the ruling of the Constitutional Court on 12 September.

Eurozone - Draghi misses out on Olympic medal

In a way, today’s ECB meeting had a lot in common with the last EU summit in June. The ECB did not deliver the big bazooka some market participants had hoped for. It only gave some hints at intentions and possible plans for the future. Much ado about nothing?


Of course, the macro-economic assessment was of lesser importance today. Obviously, the ECB has become somewhat more pessimistic about the economic outlook. While the ECB still expects a recovery of the economy; this recovery has now been labelled as “only very” gradual. Risks to the economic outlook remain to the downside. As regards inflation, they put somewhat more emphasis on the fact that inflation would continue to slow down in the coming month, dropping below 2% in 2013. Risks to the outlook for price developments remain, according to the ECB, broadly balanced. This latest slight downward revision of the ECB’s macro assessment and the fact that a rate cut was already discussed today, in our view, has opened the door further for another rate cut. It could already happen at the next meeting in September when the ECB staff will present its latest economic forecasts.

Expectations about big things to happen were high. Last week, ECB president Draghi had pushed himself into a very uncomfortable corner. The words that the ECB would “within our mandate the ECB is ready to do whatever it takes to preserve the euro and believe me: it will be enough” had given rise to speculation about imminent ECB action. Clearly, today’s press conference was a cold shower for these expectations. The ECB did not present any new measures. In fact, ECB president Draghi stressed the well-known ECB stance that monetary policy could not solve the Eurozone debt crisis. Draghi actually repeated the old mantra that Eurozone policymakers needed “to push ahead with fiscal consolidation, structural reform and European institution-building with great determination.” However, Draghi’s comments also made clear that the ECB will not leave Eurozone governments standing alone in the rain.

How? The ECB implicitly announced an SMP 2.0. Draghi said that “the Governing Council…may undertake outright market operations of a size adequate to reach its objective” [of maintaining price stability]. Nothing has been decided, yet, and the emphasis is on the word “may”. According to Draghi, the ECB will now investigate options and details of such an SMP 2.0 programme. One element of the investigations will be the issue of seniority. Moreover, according to the ECB, “adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions.” It is obvious that the ECB will stick to a principle of strict conditionality. Unlimited bond purchases, therefore, look highly unlikely. However, combining conditionality to a measure which is officially meant to tackle problems with monetary policy transmission sounds somewhat contradictory.

What do we make of all of this? One, a rate cut at the September meeting looks highly possible. Two, the ECB will not engage in any ground-breaking measures like unlimited bond purchases. Three, ECB liquidity access for the ESM is out of the question right now but has not entirely been ruled out if the structure and tasks of the ESM have changed. Four, the ECB will stick to a principle of conditionality. For governments this means that they can only expect some ECB support if they send an official request to the EFSF/ESM.

All in all, the outcome of today’s ECB meeting had been less surprising or disillusioning without Draghi’s strong words last week. The ECB simply sticks to its well-known strategy. For Draghi, it was very hard to elegantly get out of such a self-inflicted dilemma. The ECB has to master a balancing act between keeping maximum pressure on Eurozone governments, while at the same time not disappointing markets. Draghi managed this split in only a very rough-and-ready manner. It will definitely not earn him an Olympic medal in gymnastics.