Rock Star Central Banker

06/06/2014 at 3:37 pm

That is how one London-based analyst described Mario Draghi, ECB President, in an interview with Bloomberg this morning. Markets had been waiting to see what the ECB would do about the threat of deflation and this week their patience was rewarded: Mr Draghi announced an eye-catching €400bn package to stimulate bank lending and a headline-grabbing negative interest rate.

His announcement had some remarkable results. Peripheral bond yields in Europe fell still further: the ten-year Greek bond yields comfortably less than 6% again, the spread between Italian and German government bonds fell to another three-year low, and at the time of writing the yield on Spain’s ten-year benchmark remains below that of the ten-year gilt. The so-called “crossover index” of low-grade European credit spreads reached another pre-crunch low, and is within sight of where it closed 2006. The eurozone blue-chip Stoxx 50 index reached new highs. After an initial dip down the euro closed up more than half a cent against the dollar.

If Mr Draghi is a rock star, then, the crowd love him. But how radical are the changes he has actually put forward?

Having a negative deposit rate seems like a significant move. But the reduction is all of 10bp, from 0.0% to -0.1%. The impact on bank margins is therefore of mostly presentational significance. Nor are negative rates – even in Europe – as much of an innovation as all that: Sweden ran a deposit rate of -0.25% for a year from mid-2009, and the Danish Central Bank’s offered rate on certificates of deposit was set at -0.2% in mid-2012, only turning positive again this April. Longer rates have been negative too, with one-year German government paper dropping below a zero yield several times as fears over the sovereign debt crisis persisted over 2012. Consider the level of rates in real terms, of course, and this becomes even plainer, with reference interest rates well below inflation over much of the developed world now, including Japan.

The €400bn bank liquidity programme, in practice, is even less dramatic. It is limited to 7% of the value of lending to non-financial corporates and household borrowers by bank, will not kick in until September and then will only be phased in on a quarterly basis. Another programme, designed to cover net corporate lending with centrally-borrowed cash, is not scheduled to start until next March; and in terms of outright quantitative easing, all the ECB said is that it will “intensify preparatory work related to outright purchases of asset-backed securities”, which hardly sounds exciting.

The real benefit of this week’s announcement, therefore, has been the market reaction. The same goes for the ECB’s last big programme announcement back in September 2012: outright monetary operations, enabling the bank to purchase an unlimited quantity of short-dated government bonds in the event of emergency, billed in advance over the summer as doing “whatever it takes” to save the euro. It drove markets wild with relief. The number of times it has actually been used since? Precisely none: the market response was outcome enough.

This is not to dismiss the importance of “open mouth operations”. While its policy response to the credit crunch itself was exemplary, for instance, the Federal Reserve caused major carnage on two occasions further down the line: its botched announcement of “Operation Twist” in the autumn of 2011 undermined a sensible policy by heaping further panic on already fearful markets, and the announcement of QE “tapering” a year ago caused some of the most significant market dislocations in recent history. Having seen what can happen when central bankers get their delivery wrong we should be pleased that Mr Draghi, so far, has been getting his right.

There is a fundamental point worth raising too. Further emergency action from the ECB – received wisdom aside – is not necessary.

Lots of people “know”, for instance, that deflation caused a lost decade in Japan. These people agonize that the same may happen on the Continent. But what about deflation in … Switzerland? CPI inflation was at or below zero there for two years from October 2011, fell to a low before that of -1.2% in mid-2009 and has averaged -0.1% and +0.6% over the last five and ten years respectively. Yet the Swiss economy experienced one of the shortest and shallowest downturns of the Great Recession, and unlike the eurozone did not experience a double dip. It might just be, therefore, that deflation is at least as much a symptom as a cause of economic malaise.

On a similar note, there is a widespread assumption that the ECB needs a weaker euro. But is this true? If low inflation is a symptom of high unemployment and slack growth, what more would a weak currency deliver when the current account surplus has already been reaching record highs? On the other side of the coin, over the year to May – when eurozone CPI inflation fell to 0.5% on the year – the euro had only strengthened by 1.3%. Most of the currency’s appreciation came much earlier: from May 2012 to May 2013, for example, it was up over 8% on a trade-weighted basis. And in May last year CPI inflation was running at 1.4%. This should make it rather difficult to believe that Europe has been importing deflation.

We shouldn’t get carried away with the eurozone’s economic situation to anything like the point of jealousy. Remember disappointing growth and regional disparity. And it would be great to see some credit growth there along with other recent signs of recovery, such as the peak in unemployment and the strongest retail sales growth in more than seven years.

However, a proper analysis suggests that Mr Draghi has indeed been playing to the crowd as much as anything this week. Why not, when this can be as important to a central banker as a rock star?

The next time he puts on a big performance, let’s hope that too is a hit.


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