ECB Shadow Council unanimous on need to lower rates further

At the regular meeting of the ECB Shadow Council held on Thursday 26 March, there was a large majority in favour of lowering the ECB's deposit rate from 0.5% to zero. A narrow majority voted in favour of cutting the refinancing rate from 1.5% to 1.0% as opposed to a larger cut. Of the 15 members, 5 argued in favour of a cut by 100 basis points to 0.5 %, ten were in favour of a cut by 50 basis points to 1.0 %. A vote on a compromise proposition of suggesting a rate cut of 75 basis points was defeated with seven votes in favour and eight against. The expectation of those on the Shadow Council was that the overnight interest rate (Eonia) would trade down to close to zero should the deposit rate be lowered to zero.

Growth prospects and inflation forecasts made by Shadow Council members continued to decline precipitously. The nine members who regularly provide forecasts lowered their GDP forecasts for 2009 on average from minus 2.2 % to minus 3.3 % and the inflation forecasts (HICP) from 0.5 % to 0.4 %. Even with the assumption that the ECB will lower its policy rate to below 1 % in the near term, members projected that real GDP next year would grow only by 0.5 percent, along with inflation at 1.2%, undershooting the desirable inflation rate of around two percent.

20090.4 (0.5)-3.3 (-2.2)
20101.2 (1.4)0.5 (0.9)

Contributors:. M. Annunziata; E. Bartsch; J. Cailloux; J. Callow; S. King; .J. Krämer; T. Mayer; E. Nielsen; J.-M. Six
Assumptions: Forecasters assumed on average that the ECB would cut its key rate to 0.86 percent within the next three months and to 0.68 percent within six months.

The minority who favoured a policy rate cut of 100bp judged that it was highly likely that inflation would undershoot the target for a considerable period of time and that even the risk of genuine deflation was significant. Therefore, they deemed it important to deliver monetary stimulus without unnecessary delay. It was argued that cutting rates more slowly was tantamount to a delaying tactic to push back the time at which rates hit the lower bound and making a decision on how to proceed further would become unavoidable. These and some other members deemed it of utmost importance that the ECB soon clarify its stance on if and how it would provide further stimulus when the zero bound on interest rates was reached. Members in favour of a smaller cut argued that an extraordinarily large move might damage confidence and also, that preserving some rate-cut expectations was preferable to using the remaining leeway all at once.

A large majority was in favour of lengthening the terms of the ECB?s refinancing operations with banks, with a view on extending the low interest rate environment to longer maturities.

Many members of the Shadow Council did suggest that the ECB at some time would need to purchase corporate paper. There was no agreement on whether there was a credit crunch in the euro area, with some members saying the slowdown of credit expansion was mostly due to lack of demand. However, some other members stressed that it was not really possible to parse demand and supply factors and that this distinction was not very relevant. These members argued that improving financing conditions for companies was necessary and would help in either case.

Also, many members of the Shadow Council urged the ECB to be open to the possibility of enhancing liquidity by buying government debt. A major hurdle was seen in the lack of a coordination framework between governments and between the ECB and governments, and in particular the difficulty for the ECB of obtaining indemnity for any losses it might incur. Members urged the ECB to take the lead in forging a consensus on these issues. Some noted that bond buying operations of the Bank of England and the Federal Reserve did not seem to have been a clear success, so far.

Several members advocated that the main responsibility for supporting the economy now was with European governments, who should provide further fiscal stimulus. Several members expressed dismay over the fact that the European Commission had already launched excessive deficit procedures against some member states.

Membership Changes

Jörg Krämer, Chief Economist of Commerzbank in Frankfurt joined the ECB Shadow Council to replace outgoing member Daniel Gros, a founding member of the group.

Individual Votes

Members' individual votes for March 5:
Jose AlzolaThe Observatory Groupcut 0.5
Marco Annunziata


cut 1.0        
Elga Bartsch

Morgan Stanley

cut 0.5
Agnes Benassy-QuereCEPIIcut 0.5
Christian BordesParis 1 Universitycut 0.5
Jacques Cailloux


cut 1.0
Julian CallowBarclays Capitalcut 0.5
Giancarlo CorsettiEurop. Univ. Institutecut 0.5
Stephen King


cut 1.0
Jörg Krämer


cut 0.5
Thomas Mayer

Deutsche Bank

cut 0.5
Erik NielsenGoldman Sachscut 1.0
Jean-Michel SixStandard & Poor'scut 0.5
Angel UbideTudorcut 1.0
Charles WyploszGrad. Institute. Genevacut 0.5

Frankfurt, March 26, 2009
Norbert Häring
Non-voting Chairman

Appendix 1

Quotes from individual members of the Shadow Council
(in no particular order)

"Quantitative easing needs to be handled with care, especially since it can send scaring signals about inflation in the long run. Such outcome would be counter-productive if the ECB wants to flatten the yield curve. For this reason, the ECB should urgently talk with government about how market risk will be handled when it comes to shrinking its balance sheet. More credible fiscal commitments would also help both the ECB and governments themselves to loosen the policy stance in the short run."
Agnès Bénassy-Quéré, Director of CEPII

"I would be in favour of extending the refi operations beyond the current six month time-frame. Instead of offering these longer maturities as fixed rate tenders, I would deem variable rate tenders more appropriate at longer maturities. In my mind, refi operations have a number of advantages over outright purchases of financial assets, most notably that the banking system would be able to benefit from a future recovery in these assets."
Elga Bartsch, European Chief Economist of Morgan Stanley

"The ECB should recognise the rising risk of deflation in the euro area (even if still low) and respond by cutting rates by 100bps at the April meeting. Short term rates need to be low and considerations about the level of the deposit rate look superfluous. In order to bring the cost of funding of euro area corporates down, the next step is to engage in the purchase of private debt instruments. The ECB should announce that it stands ready to implement such a program."
Jacques Cailloux, European Chief Economist of Royal Bank of Scotland

"With market rates converging to zero, the emphasis should now switch squarely to quantitative easing measures. The ECB should extend the maturity of its liquidity provisions, but prepare for direct purchases of corporate bonds, as the current strategy of working through the banking system might not be enough."
Marco Annunziata, European Chief Economist of Unicredit in London

"The aggressive monetary easing by the ECB is gaining some traction when we consider the sharp acceleration in M1 and in banknotes in circulation. If policy is to veer on the side of recklessness from here, I favour that it we see this with more fiscal stimulus rather than with aggressive bond purchases by the ECB."
Julian Callow, Chief European Economist of Barclays Capital

Appendix 2

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economist?s drawn from academia, financial institutions, consultancies and research institutes.

The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a physical meeting). Its discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon. Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitutes the panel's forecast consensus as published each month.

The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinion about what the ECB should do, rather than what they forecast it to do (and hence the "normative" views as expressed by Shadow Council members on what they consider the ECB ought to do can and often do differ from what they might say they expect the ECB to do). This "normative perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council.

Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, though Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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