Konjunktur ECB Shadow Council discusses when monetary stimulus should be withdrawn

Experts discuss the implications of improved economic conditions for central bank policy Latest comment by:   José Alzola (closed)

Elga Bartsch

In my view, the recent more encouraging data flow provides little reason for the ECB to change its current policy stance. The only thing the better than expected data show is that the recession was a tad shallower than many, including myself, had feared and that activity is now stabilising at a low level. As such, the recent data flow thus makes calls for further rate cuts obsolete. That said, the ECB staff projections are clearly too gloomy and will have to be revised up. At the same time, the inflation projections seem about right to me. Looking beyond the upcoming meeting, I think that the ECB can leave the current refi rate level as well as the generous liquidity supply in place for an extended period of time. Only once inflationary pressures come back into the policy relevant time horizon there will be a need to raise rates. In my view, this will only be the case around the middle of next year as I expect inflation to approach the 2% mark at the earliest in late 2011. The ECB's hand could be forced earlier, though, if inflation expectations suddenly start to climb on a sustained basis to levels that are consistently above the ECB's (and also our) inflation norm. Ahead of hikes in the refi rate, the ECB should bring the EONIA overnight rate closer to the official policy rate again. This can be done through several different routes. One would be to narrow the corridor between the deposit rate and the standing facility again. One would be to mop up liquidity through reverse refis or through issuing debt certificates. I would favour the latter. A further option is to be less generous with liquidity supply in the first place and switch back to variable refi operations - either for selected tenders or for all of them. Such a switch would not be advisable in my view because it requires a fully functioning money market. As market dislocations that make it difficult for individual institutions to obtain funding at all times will likely persist, ex ante the ECB should be generous at the "liquidity tap", I think. Instead, it should then mop up the "liquidity spills" ex post.
Elga Bartsch is Chief European Economist of Morgan Stanley in London

Jacques Cailloux

When it convenes for the September policy meeting, the European Central Bank will, for the first time in two years, revise upward its GDP forecast for 2009 and 2010. These revisions will provide the clearest message to date that the worst of economic contraction is likely behind us. The recent impressive recovery in financial markets and the unwinding of the negative confidence shock that followed the demise of Lehman Brothers might even tempt observers to claim victory on the sustainability of the recovery. I personally remain very cautious and will remain so as long as I do not see any evidence of sustainable recovery in final demand in the euro area or in key exports markets. In fact, the consumer has only avoided a major retrenchment thanks to a combination of lower inflation and significant fiscal support. While this has allowed mitigation of the negative shock in the short term, it does not create the conditions for a sustainable recovery. A key determinant of sustainability is the labour market. While the pace of labour market deterioration might have passed its peak, the euro area is still likely to see net job losses and a rising unemployment rate until well into next year. This will contribute to depress consumers' income and push personal insolvencies higher. As such I believe it is far too early to talk about exit strategies.
Jacques Cailloux is European Chief Economist of Royal Bank of Scotland

Marie Diron

Given the outlook for growth and inflation, the ECB should keep its policy unchanged for a long time, probably until some time in the first half of next year. At that time, liquidity can be gradually withdrawn. Rate rises should probably not be implemented until later. This protracted period of very loose monetary policy is warranted by the fact that, despite now clear evidence that the bottom has been reached, chances are that the upturn will be slow and unsteady. Q2 growth has surprised on the upside and the latest indicators like the August PMIs suggest that growth in the second half of this year will probably be of the same order of magnitude as in Q2 as the fiscal and monetary stimuli reach the economy. But there are still concerns about the sustainability of growth once the effects of the stimulus packages wane. So far, the brunt of the downturn has been borne by companies that have seen orders and profitability plummet. Consumers have been relatively shielded as unemployment has not risen much (on average at least, with some exceptions like Spain) and inflation has fallen. It could be that the schemes that have helped preserve jobs last long enough until activity picks up and companies are ready to step up production with their existing, retained, staff. But there is also a risk that these schemes prove too expensive and that unemployment rises rapidly next year even as activity increases. With only a moderate further rise in unemployment in our central forecast, we do not expect inflation to return to 2% until the end of 2011/2012 and the risks to this forecast are on the downside. All in all, this is not an environment that warrants a withdrawal of monetary stimulus in the foreseeable future.
Marie Diron is Senior Economist at Oxford Economics

Gustav Horn

The ECB should lower rates down to 0.5 % soon to speed up recovery first in the banking sector by widening profit margins and then in the rest of the economy by lower rates throughout next year.Only once there is a stable upturn should the ECB raise rates. Excess liquidity will have already dimished until then because e.g. the interbanking market will function again, such that the liquidity provided by the ECB to replace this market will no longer be demanded by banks.
Gustav Horn is Scientific Director of IMK Macroeconomic Policy Institute

Erik Nielsen

I will join chorus of members arguing for leaving monetary stimulus intact. Ideally, i would have liked lower rates, but it doesn't matter much given where o/n and 3-month money is - so, happy as we are; dont change anything.
Erik Nielsen is Chief European Economist of Goldman Sachs

Thomas Mayer

Regrettably, the Shadow Council at its last session at the end of June voted for a significant rate cut, although evidence for an imminent recovery had already emerged. Meanwhile, this evidence has firmed, and I now expect Euroland GDP growth to accelerate to 1.3% next year. To be true, this is still very moderate growth, Moreover, at 0.9%, I expect inflation to remain below "target". However, monetary policy has been extremely easy for some time now, and although I do not see the need for an exit from this position soon, I do not see why it should be eased any further. In fact, from a present perspective I could envisage a gradual normalisation of monetary policy in the course of next year (with non-standard measures to be phased out in the first half and a moderate rate increase in the second). We often agree that monetary policy has to be designed with a view to the future. All too often, however, we let ourselves be guided by the recent past. I do hope that the Shadow Council will look ahead this time.
Thomas Mayer is European Chief Economist of Deutsche Bank

Jörg Krämer

One thing is clear: The recession is over and the next interest rate move should be up and not down. However, for the time being there is still a high degree of uncertainty about the sustainability of the economic recovery. Therefore, I would recommend not to hike rates already next week. The ECB should, however, not repeat the error to wait too long to start the necessary normalisation process. If a double dip can be avoided after the turn of the year it should start to hike interest rate.
Jörg Krämer is Chief Economist of Commerzbank

Angel Ubide

The near term outlook seems to be a bit better at the margin, as the output decline is less pronounced than expected. Sentiment has recovered, and thus the balance of risks seems to be a bit more balanced in the very near term. However, the visibility regarding next year's growth remains low, with the risk of higher and persistent unemployment that will weigh down on consumption. This balance of risks would argue for no more easing - considering that the policy stance is, de facto, 0.5 percent; I would have preferred a more transparent policy of cutting the policy rate to 0.5, but there is no point in continue arguing - but no tightening either, and thus monetary policy actions should be geared towards maintaining an eonia rate around 0.5 percent.
Angel Ubide is Chief Economist of Tudor Investment Corporation

José Alzola

While I remain skeptical about the strength of the starting recovery (beyond, perhaps, one or two decent quarters in 2H '09) it is undeniable that downside risks have diminished and that some upside risks have emerged. On balance, I think that conditions no longer justify maintaining a downside bias on rates. At the same time, underlying price pressures are very low and likely to remain so through 2010 and, absent an unlikely strong recovery, also beyond. Thus, a policy rate of 1% still is, and is likely to be for a long time, appropriate. Another, less important question, is whether the ECB should introduce a spread over the policy rate at the next 12-month repo operation. The first one (in June) attracted massive demand (€ 442 billion) and if repeated in the September and December repos -- for which the ECB has pledged to satisfy also all the bids -- then the ECB's balance sheet will expand beyond its control for as long as one year. I think this would be undesirable. However, there are arguments against,especially that it could be interpreted as the start of monetary tightening, which would be inappropriate. In addition, demand is unlikley to be that high again, because banks have now excess liquidity (they are re-depositing € 160 billion at the ECB at a penalizing rate of 0.25%). All in all, I think it would be wise to maintin the 12-m repo still at 1%. After all, the ECB's commitment to satisfy all bids ends in January.
José Alzola is Senior Economist of The Observatory Group

Angel Ubide

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