Besides the increasing virus infections and the dangerous volatility coming from the US, two main points became more visible, augmenting downside risks for Europe: likely insufficiency of fiscal policy and possible credit supply deceleration due to a stressed banking sector !/7
The first stems from the delay of the Recovery Fund (NGEU) disbursements and the possible caution of national fiscal policies, after a year of big deficits in 2020. The regrettable protracted timetable for the NGEU payouts is in this ECB chart 2/7 ecb.europa.eu/pub/pdf/ecbu/e…
The recovery depends mostly on fiscal policy staying expansionary, as consumers increase their savings and investment suffers from unused capacity and lack of demand. The suspension of the Stability Pact for 2021 was welcomed, but we need a deep revision of the Pact 3/7
Second, European banks are under market pressure with their stocks at the lowest values ever (STOXX Europe 600 banks chart). Criteria and standards of credit supply were slightly tight for NFCs and a lot for households, though credit increased 4/7 ecb.europa.eu/stats/ecb_surv…
Indeed, new NFC loans increased yoy because of monetary policy but mostly due to public guarantees (see yellow bars below). However, guarantees may start to unwind because of fiscal policy, and standards for credit decisions may not ease enough .5/7 ecb.europa.eu/pub/pdf/ecbu/e…
There will be capital erosion when loan losses step-up next year. Low profitability, and lowest ever Price-to-Book ratios, make it more difficult to raise capital. See @Schuldensuehner“All listed German banks have a combined mkt cap of ..€21bn” 6/7
Public policies will have to support the banks later next year to keep-up needed credit supply, including the use of financial stability reasons existent in the legislation or, in the still unlikely worst-case scenario, even tweaking or temporarily suspending the BRRD. 7/7
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Macron dramatic: Europe is mortal and may die. He said it in his recent speech and repeated it in an interview with The Economist. The warning was matched by his lofty rhetoric in identifying the challenges and their solutions (military, industrial, environmental, political) 1/
His vision is very ambitious. He demands a European Defence with nuclear weapons, European industrial champions duly supported and protected, a true Green Deal, Energy safety, a Union Council of Homeland Security, a dual mandate for the ECB, the doubling of the EU budget… 2/
The recent report on the Single Market by Letta is also very ambitious, as certainly it will also happen with the Draghi June report on European competitiveness. Macron quantifies the financing in between € 650 to 1000 bn of additional annual expenditures, public and private 3/
The ECB announced that it will take a decision in March on the very important issue regarding the future operational framework to use a policy rate to influence the interbank overnight rate. The decision is also linked to the issue of the future size of the balance sheet. 1/11
I fear a mistake may be made if the decision departs from a “floor system” that has been quite approximately followed by the ECB since 2088 and then in a full-fledged way since 2015. Instead of the volatility of the Eonia until 2008, the floor system worked perfectly (slide) 2/
A few decision-makers seem to consider that market rate volatility around the policy rate are a good thing. Markets like volatility for profitability in other contexts. In this case, the deviations only show that the CB is not able to attain its targeted market rate 3/
Disinflation momentum in the Euro Area has broadened. That will be reflected in the future wage/price decisions, contributing to a future decrease in core inflation that, wrongly, has been taken as the proxy target of monetary policy 1/
The DB index of the ECB’s Governing Council indicates an increase in divergence of views about the future, according to public statements of its members 2/
The PMI composite (manufacturing and services) for Germany turned more negative, indicating a more visible negative growth in the biggest EA economy 3/
A missed debate in the ECB’s Sintra Forum was about the desirable size of the CB’s balance sheet. The paper dealing with the issue missed the point by using as the sole criterium the maximising of the reserves supply net convenience value 1/ecb.europa.eu/pub/conference…
The convenience value is the price premium that very liquid and safe assets (e.g. AAA sovereign bonds) can get in the market. The paper took the view that the balance-sheet size doesn’t matter to MP when the policy rates are above the effective lower bound. This view is wrong 2/
As it’s known, conventional monetary policy targets the interbank market rate for 24h. In a corridor system, the CBs have a lending facility rate (the discount window in the US) and a lower deposit facility rate (the IOR in the US), and the policy should be in the middle 4/
The Sintra ECB Forum started this year with an excellent paper, presented by Silvana Tenreyro, on “Monetary policy in the face of supply shocks:the role of inflation expectations”. Theory and mainstream models give an exaggerated role to expectations in the inflation process 1/
Woodford (2003) wrote that monetary policy is mostly about managing expectations and that hardly anything else matters. The models made expectations endogenous with rational expectations but the mechanisms that would operate in reality were never really well explained 2/
The use of the Euler equation in the main models, implied that higher (lower) inflation expectations would reduce (increase) real interest rates and so intertemporal optimization would entail frontloading (postponing) of consumer expenditures. 3/
As predicted, euro area inflation in March tumbled to 6.9% from 8.5% in February (see the Eurostat table). I expect a similar decrease for April. This means that inflation is on its way down to the level implicit in the ECB projections, close to 3% by December this year 1/
These results come from the drop in international prices and the delayed effect of monetary policy. Interest rate changes take time to produce their effect on the economy. Decisions now must be taken thinking about future inflation, i.e. the 3% in Dec and lower in 2024 2/
Market commentariat makes 2 mistakes: a) “But “core inflation” is still too high”; b) So, “more rate hikes are needed”. The target of policy is headline inflation (what counts for consumers). “Core” inflation only matters if it is a good predictor of future headline inflation 3/