ECB: Reaching the limits of its mandate to revive the Eurozone economy

The EU Macroeconomic Dialogue took place on 07 July 2014, in Brussels. Mario Draghi, European Central Bank President (on the left) and Jeroen Dijsselbloem, President of the Eurogroup participated in it. Shoot location: Brussels Shoot date: 07/07/2014 (European Council, Council of the European Union, TV Newsroom).

Everybody agreed that what the European Central Bank decided last week (to lower its basic interest rate to 0.05% and purchase asset backed securities and covered bonds) came as a surprise. As a result, stock and bond markets throughout Europe celebrated this additional almost zero cost liquidity, which Mario Draghi, ECB’s President, is ready to release during the next months to Eurozone’s financial system. Unfortunately, very little attention was paid by market makers to the reasons Draghi eloquently invoked or even didn’t openly mention for these additional measures. To be reminded that, last Thursday he presented these last policy tools, only three months after last June’s package, when the ECB had decided to flood Eurozone banks with up to one trillion euro of zero cost liquidity.

Of course markets are always in search of reason to party or be distressed. Only in this way market makers can make some additional profits for themselves. But let the marketeers do their tricks and let’s return to the important side of news. In this case, Draghi was straightforward. He pointed to the growth that isn’t coming and to disinflation (falling inflation) that may turn to deflation (negative inflation) as the reasons for this additional package of measures.

More billions for bankers

He said, “Following four quarters of moderate expansion, euro area real GDP remained unchanged in the second quarter of this year compared with the previous quarter. While it partly reflected one-off factors, this outcome was weaker than expected. With regard to the third quarter, survey data available up to August indicate a loss in cyclical growth momentum”. Some minutes before he had stressed that, “Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate”.

Despite the economic stagnation and the approaching danger of deflation that became quite clear in August, Dr Jens Weidmann the Governor of the German central bank, the Bundesbank, has reportedly voted ‘no’, trying to block the new monetary package. As it turned out, he couldn’t stop the new policy measures and Draghi’s proposal was upheld with a debilitating majority. Weidmann is reported to have preferred that the ECB had better wait for at least a few months, until the June package had worked its way through in the economy. In the mean time however even the German economy lost some ground in August showing negative growth.

Why Germany opposed to Draghi?

Why, then, the German banker tried to block this extra effort to revive the Eurozone economy with a new liquidity package, targeted to help the real economy finance some new investments? The answer is very simple. Germany is the by far one of the largest moneybags of the world and as a net lender detests any interest rate cut as the last one. To be noted that last Thursday the ECB package had in its forefront a decrease of its main interest rate to 0.05% from 0.15%. By the same token the representatives of the German banking and insurance industries came out in support of Weidmann, strongly criticising the new interest rate cut.

The August of truth

Now let’s return to the question, what changed during the last three months that made the ECB rushed last week to add more liquidity to the financial system, on top of the June trillion? In principle, haste should not be a characteristic of central bank policy. It is a sign that may tempt some people to make negative thoughts. Despite that, stock and bond markets last week celebrated the hastily made announcement of additional liquidity, without paying much attention to the reasons that led Draghi not to mind being seen to take hurried decisions.

The President of ECB had a lot to say about that. As a matter of fact, on Thursday 4 September in the Press conference during which he presented the new measures, Draghi took a lot of pain to explain the rush. Asked why the ECB is seen “acting in a kind of hasty manner” he replied: “This is a very natural question to ask, and one should ask, what has changed since then? What happened in August is that we’ve seen a worsening of the medium-term inflation outlook. We have seen a downward movement in all indicators of inflation expectations across all maturities…Add to this that I would say most, if not all, the data that we got in August, both hard and soft, on GDP and inflation, as I said in the introductory statement, showed that the recovery was losing momentum. The growth recovery was losing momentum. So the Governing Council basically decided to a great extent to strengthen the measures, complete and strengthen the measures decided in June. In this sense, the ABS outright purchases could be viewed as a measure that strengthens the TLTRO”.

To be reminded that last June the ECB, with those ‘Targeted Long Term Refinancing Operations’ (TLTROs), decided to inject to Eurozone banks additional and almost free of charge liquidity, of up to one trillion euro. The above quote describes in detail the two very good reasons why the ECB, only three months after June, announced additional monetary measures, meant to further strengthen the liquidity of the banks. Those dreadful realities are the fading out of an already weak and uneven recovery, and the evident tendency of the inflation rate to cross the Rubicon and pass to the negative part of the chart, God forbid.

The banks celebrate

There are two reasons why the financial markets celebrated last week’s announcement. Not to forget that the driving forces of the financial markets are primarily the banks and their insurance affiliates. Then to the reasons; firstly, as mentioned above market makers are always in search for opportunities to party or mourn and by those oscillations cash in important commissions and own gains. Secondly and more importantly, this second package of free liquidity is even of longer term than the TLTROs. The purchases of Asset Backed Securities and covered bonds by the ECB from the financial institutions will flood the banks with billions of timeless cash.

Of course the banks will use much of that cash along with large parts of the TLTROs for their own dark purposes, namely to bet in every possible and impossible market, from rice and wheat to interest rate and credit risk derivatives and other peculiar instruments. While the TLTRO credits have super generous maturity of four years, the purchases of ABSs and covered bonds will offer to banks liquidity injections without an expiration date. The banker’s dreams come real…

What about Draghi? Doesn’t he suspect that? Of course he does but there is no other way to do something to revive the Eurozone economy. If the ECB doesn’t do it nobody else will, because everybody else, including Berlin and Paris on many occasions have proved they care only for their own national interests. As for Brussels, both the Commission and the Parliament are helpless when it comes to by and large growth policies. Apparently, there is no institutional force or formal Eurozone authority other than the ECB, underpinned by truly European inspiration and insight, and as it lately appears also by means of determination. This is so, simply because the central bank is governed by majority vote, without Brussels like endless bureaucratic procedures, while disposing immense powers in the monetary field.

To underline this reality Draghi concluded as follows and it won’t be a pointless repetition to quote it again: “Should it become necessary to further address risks of too prolonged a period of low inflation (n.b. and stagnation), the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate”.