No change in ECB policy but Draghi fights his corner ......

Friday 22nd April 2016

No change in ECB policy but  Draghi fights his corner ......

ref : "ECB obeys law, not politicians", Draghi says, in riposte to German rates sniping" , The Financial Times

You know, we were going to offer an immediate take on the European Central Bank's policy announcement yesterday afternoon but in the event decided to let things settle down a bit. Very fortunately, we can do that as we're not a bulletin service offering instant analysis --  which is probably just as well because, to be perfectly honest, we would have struggled to offer any logical explanation for the knee-jerk reaction on foreign exchange markets that followed the ECB decision.

Just to recap, the ECB left its monetary policy unchanged ..... which is to say benchmark interest rate at 0%, deposit rate at minus 0.4%, and QE asset purchases at 80bn euros per month. This was just about universally expected so why , in the immediate wake of the announcement, should the EUR/USD rally a cent to near 1.14 ? Good question, and the gains were soon given up (and more, currently 1.1272). The general consensus is that the spike reflected disappointment on the part of some Euro bears that the ECB hadn't introduced anything more accommodating. That would seem to be asking quite a lot of a central bank, not least that it tailors its policy to your trading position, and quite frankly to see the rate fall back again once they'd scrambled to cover their Euro shorts in thin conditions is probably no more than they deserved.

Some were putting the spike in the Euro down to a jump in Eurozone bonds yields ..... the yield on the 10yr German Bund leapt from 0.15% to 0.24%. Mmmm .... not totally convinced about that. The timings of the two moves were out, and if this year has taught us anything it's that the traditional (and logical ?) dynamics between interest rates and currency levels no longer applies in the same way that it used to. Besides, bond yields are still much higher than pre-ECB decision levels even as the Euro slides.

Still, it was undoubtedly a BIG move in bond yields and at least we can be sure of most of the reason behind it  --  in his press conference, ECB President Mario Draghi gave further details of the kind of corporate bonds the ECB will include in its QE bond-buying programme. As he spoke, the perception grew that at least some significant demand would be diverted from government bonds .... hence lower prices / higher yields.

Mr Draghi had plenty of other interesting things to say : No change in policy because time was required to judge how effectively the extra stimulus given in March is working. Nevertheless, the risks are on the downside, especially with regard to inflation, or the lack of it. Consequently, the ECB is both willing and able to ease policy still further if deemed appropriate.

This is unlikely to have been music to the ears of Germany's politicians, or its media come to that. But Mr Draghi has been on the receiving end of such stick from both quarters recently that it was fun for the neutral to watch him give a bit back, more than a bit in fact. In essence, his points were that :

The Eurozone would be in a much worse state had the ECB not eased policy as it has

The ECB followed the law, not the whims of politicians, and must remain independent

The ECB's mandate was for fostering growth and price stability in the whole of the Eurozone, not just Germany

Monetary policy can only do so much  --  individual nations must also contribute through structural reform and fiscal stimulus

You have to feel that this last point was aimed squarely at Germany. For the layman, "structural reform" can seem like a catch-all term that could do with some specifics. Moreover, it is generally thought of as something than applies largely to peripheral nations. Not so. It's not just Germany's savers that are suffering from ultra-low interest rates. Its banking system is different from most others in that includes a much larger layer of smaller banks that rely on interest income for profits. In addition, pension funds and life insurance companies who guarantee minimum return on investments are up against it. The implication is that Mr Draghi is suggesting that perhaps it is their own business model and regulatory framework that is the main cause of their problems.

If so, it seems highly likely that, despite combative Finance Minister Schauble stepping back slightly from his more astringent comments of late, the war of words will continue.