Konjunktur Shadow ECB Council: Is it time to move toward the exit or should the ECB rather loosen policy further to prevent the euro from soaring higher?

Some on the ECB Governing Council push for a move toward a more normal monetary policy stance. At the same time, other large central banks, notably the Federal Reserve, prepare for a new round of monetary easing. The members of the Shadow ECB Council focus their pre-meeting discussion on the question if the ECB can afford to go in the other direction. Latest entry by:   Manuel Balmaseda

Elga Bartsch: "Appreciation of the euro isn't an issue (yet)"

In my view, the recent appreciation of the euro is not yet an issue. First, it seems to me that the initial currency market reaction to the announcement of renewed quantitative easing in the US is already loosing momentum. In addition, the reaction has been largely limited to the EUR/USD exchange rate. As a result, the move in the trade weighted exchange rate is more muted. Second, even if the renewed monetary stimulus in the US would push the euro into the mid fourties this is unlikely to have a big impact on the growth outlook for next year. If you take into consideration that growth momentum is still holding up better than expected in 2H, the higher carried over growth offsets some of the currency-caused headwinds. Third, we need to look at the reasons for the strengthening of the euro. Renewed quantitative easing will likely support the US economy - another effect that we need to take into consideration. To sum up, for me to become concerned about the move in the euro it would need to go considerably beyond the current move. This is not to say that I am not worried about the rise in protectionist tendencies around the world - both in trade and in exchange rate policies.
Elga Bartsch is Chief European Economicst of Morgan Stanley

Marie Diron: "The stronger euro argues against rushing toward the exit"

There is very little that the ECB can do about the euro appreciation. Verbal intervention is probably its only resort and the impact is likely to be limited if significant at all. The stronger euro will probably shave a few decimal points off GDP growth and inflation over the next few quarters. But the latest levels are not yet hampering growth significantly. In effective terms, the euro has appreciated by about 6-7% from the September lows. However, the euro is likely to continue to appreciate given the very different monetary policy stances on the two sides of the Atlantic. An even stronger euro adds to the arguments against rushing towards the exit. Eurozone growth has surprised on the upside in the second quarter. It was probably still robust in Q3, albeit much lower than in Q2, given a remarkably robust German economy. But the raft of fiscal measures are only starting to hit the economy. Combined with a worsening outlook in external markets, this implies that now is not the time to start tightening monetary policy. Instead, the ECB should stand ready to provide support to the economy as it goes through fiscal retrenchment.
Marie Diron is Senior Economist at Oxford Economics

Gustav Horn: "The economy is far away from a self-sustaining upturn"

An exit from quantitative easing and low interest rates would still be premature. The Euro area economy is stuck on a path of cautious recovery far away from a self-sustaining upturn with higher than pre-crisis capacities and employment. Consequently there are no inflationary dangers. The inflation rate is still below the target and expectations are well in line with price stability. Given the fact that most European governments will enter a restrictive fiscal course no change of economic dynamics for the better should be expected for next year. Therefore, if anything, policy should be loosened.
Gustav Horn is Scientific Director of IMK institute

Erik Nielsen: "Fixed rate full allotment is an uncomfortable set-up"

There is no particular rush for the exit, given the forecasts. That said, fixed rate full allotment is an uncomfortable set-up, so i would recommend a phasing out over the next 3-6 months of the full allotment of everything apart from 7-day money - with a view of then starting to end the 7-day full allotment as well. I do not believe that the ECB should start to target the euro explicitly, but if we were to see further sizable appreciation (in trade-weighted terms) then that would justify a delay in the phasing out of the full allotment procedure with a view to try and nudge eonia lower again.
Erik Nielsen is Chief European Economist of Goldman Sachs

José Alzola: "The ECB should be open to consider further rate cuts"

The Euro area’s economic recovery remains fragile and is not yet self-sustaining. If anything, fiscal retrenchment and some moderation in emerging markets create downside risks around the current sub-par recovery path. In these circumstances, the appreciation of the euro adds to those downside risks. The ECB should not encourage further appreciation by taking a policy direction opposite to that of the other major central banks, especially at a time when there are no inflation risks in sight over the medium term. Specifically, the ECB should try to avoid additional increases in term Euribor rates (up by about 30 bps over the past six months) by maintaining generous liquidity conditions in interbank markets, including full allotment indefinitely for, at least, weekly and monthly repos. In forex markets, verbal intervention is unlikely to work for long, implying that the ECB should be open to consider further policy rate cuts (there is still about 75 bps left) if the euro rises significantly further in coming months.
José Alzola
is Senior Economist at The Obesrvatory Group

Marco Annunziata: "Benign neglect is the right attitude"

The ECB should definitely not loosen policy further to take pressure off the euro at this stage. Now that euro-dollar has stabilized around 1.40 even with expectations of a new round of quantitative easing in the US, and as the appreciation of the trade weighted rate has been moderate, the ECB’s best attitude to the exchange rate is one of benign neglect. The Eurozone’s economic recovery is losing momentum, but it keeps unfolding, and the ECB should continue its gradual and prudent exit strategy, accompanying the improvement in macroeconomic and financial conditions. This should mean phasing out the 3-month full-allotment auctions at year-end, and slowly unwinding the rest of the enhanced credit support measures over 2011. The recovery is weak for structural reasons, reflecting a lower potential growth rate in many Eurozone member countries, and is still consistent with a removal of the exceptionally accommodative policy stance which was put in place at the height of the crisis. Only a further significant appreciation of the euro, to a 1.50-1.60 range, would in my view justify slowing down the exit strategy, as such appreciation would imply a further significant tightening of financial conditions and a drag on the pace of the recovery. Marco Annunziata is Chief Economist of Unicredit

Jörg Krämer: "Time to move to the exit"

The recession is more than one year behind us. It is time to move to the exit, e.g. by officially abandomn the government bond purchase programe.
Jörg Krämer is Chief Economist of Commerzbank

Jacques Cailloux: "The ECB's confidence is reminiscent of 2001 and 2008"

The ECB's new found confidence about the outlook seems yet again to be at odds with what almost every other central bank is currently witnessing. This reminds me of 2001 and 2008 when the ECB tried for a few months to depart from other central banks' policies because it thought the euro area could decouple from a slowdown in its major trading partners. In this context I see two possible scenarios: either the ECB is right about the recovery and in that case the Fed is wrong to engage in additional quantiative easing. In that case the euro will appreciate further and do the ECB's work in terms of tightening. Or, the ECB is wrong about the recovery and the Fed is right, implying that the euro has reached a peak. In both cases though, the ECB's policy decisions remain tied to that of the Fed. It is thus very important at this juncture that the ECB eases its rhetoric and move to a wait and see stance on its exit strategy to assess the nature of the Fed policy response and how robust the European economy really is. The periphery situation, while less talked about, remains extremelly precarious which would clearly argue against returning to variable rate tenders as early as in Q1 2011.
Jacques Cailloux is Chief European Economist of Royal Bank of Scotland

Andrew Bosomworth: "The exit is already here"

The ECB does not need to move toward the exit, it is coming to the ECB. Base money supply amounted to €1.1 trillion in October. While still about 8% above the level that would have prevailed had it grown at its long term trend without the financial crisis ever happening, the base money supply is falling sharply because banks’ precautionary demand for money is waning. Banks have reduced borrowing from the Eurosystem to a level effectively consistent with a normalization of the ECB’s extra liquidity providing operations. Despite this near-normalization of money market conditions, four factors suggest the ECB should continue to maintain an accommodative stance. First, money market interest rates have increased, 3-month Euribor by 40 basis points for example, as a direct consequence of less liquidity. Higher money market rates impart a tightening of monetary conditions on borrowers whose loans are indexed to Euribor. Forward Euribor interest rates for delivery in 2011 are already commensurate with a full exit of the remaining excess liquidity. Second, the euro’s nominal effective exchange rate has appreciated by 5% since May. Coupled with higher interest rates in the euro area, the possible implementation of more quantitative easing in the U.S. and U.K. plus Asian countries’ slow response to fully expose exchange rates to market forces, the relative monetary policy stance between the euro area and its trading partners points to a further 5-10% appreciation of the trade weighted euro. Third, the fiscal stance in the euro area will tighten in 2011, particularly in those countries whose borrowers are already exposed to substantially higher interest rates relative to yields on German Bunds. Fourth, the non-financial corporate sector continues to deleverage and ongoing growth in lending to households, while currently positive, remains at risk of strict lending conditions and reductions to disposable income associated with tighter fiscal policy. Inflation is not a risk in this environment. In order to support economic growth, it is imperative that monetary conditions not tighten further. Short of reducing the policy rate, there is little the ECB can do to offset higher money market interest rates and rise in the euro’s external value. At the same time, it is questionable whether the economy is sufficiently strong enough to resist tighter monetary conditions associated with the indirect policy exit currently occurring. This suggests policy rates should at least remain unchanged for the foreseeable future, including maintenance of fixed rate, full allotment lending operations. Should, however, the stock of base money contract below its trend level or lending to the private sector weaken for a sustained period, further easing would be warranted. For now this does not look likely, but the risks are skewed to the downside.
Andrew Bosomworth is head of portfolio management in the Munich office of Pimco

Angel Ubide: "Rates and full allotment are different instruments with different objectives"

I think the ECB is doing the right thing by slowly signalling that the normalization of liquidity policies will continue. Banks and their owners must understand that the emergency situation can't last forever, and governments must step in. At the same time, there is no need to rush, given the still fragile state of some EU economies and subdued inflation trends, and thus the ECB can proceed by shortening the maturity of the full allotment operations. If the euro were to appreciate substantially and introduce downside risks to inflation - a situation that for now remains only hypothetical - then the ECB should cut rates, rather than expanding the full allotment. These are two different instruments with two different objectives. Rates to manage inflation expectations and full allotment to manage liquidity needs. An appreciation of the euro that puts downside risk to inflation should therefore be dealt with by cutting rates.
Angel Ubide is Chief Economist of Tudor Investment Corporation

Thomas Mayer:"The bond purchase programme is no longer needed"

Many good arguments have already been given for and against extending the non-standard policy measures the ECB adopted during the crisis. I come out on the side of those advising a gradual exit from here on. As a first step, I favour ending the sovereign bond purchase programme. This was decided in an emergency situation as a bridge to stabilise markets until the EFSF was ready. It is now no longer needed. If a country cannot borrow in the market it should go to the EFSF. Continuing the programme any longer only dilutes the mandate of the ECB and hurts its credibility. Early next year, when the year-end scramble for liquidity is over, the ECB should return to normal refi operations. Banks that cannot cope under the normal regime ought to be restuctured or closed. If a government lacks the money to do this and cannot borrow in the market it should go to the EFSF. The ECB should also restrict the acceptance of sovereign bonds as collateral in refi operations from countries that use their banking system to fund their borrowing needs through the ECB. While the exit from the non-standard measures takes place the refi rate should remain at its present level.
Thomas Mayer is Chief Economist of Deutsche Bank

Janet Hernry: "This is not the time to move toward the exit"

With the level of activity still well below the pre-crisis trend, monetary conditions having already tightened to some degree and corporate credit growth showing only tentative signs of stabilisation, this is not the time to move towards the exit either for policy rates or ending full allotment for liquidity provision. Over time the ECB should take further steps to normalise their refinancing operations both to prevent distortions and to put pressure on governments to resolve their financial sector problems. But I think it would be premature to terminate the full allocation at the three month LTROs at a time when peripheral banks are still so dependent on it. The risk is that the it may have to be reintroduced again. Instead the ECB could make some adjustments to its collateral policy. On the euro, I don't think the current level of the euro poses a major risk to the Eurozone growth outlook and with the first stages of a new round of quantitative easing probably already priced in to currency markets, we could see some retracement of the euro near term. However, the implication of ongoing US quantitative easing policy will be to put upward pressure on the euro. It is not within the remit of the ECB "to fight" an appreciating euro but aggressive FX appreciation from here would imply an undesirable tightening of monetary conditions and pose a downside risk to growth, hence the need for caution in the exit strategy.
Janet Henry is Chief European Economist of HSBC

Manuel Balmaseda: "The ECB should err on the side of caution"

While there are arguments that would suggest that the ECB should begin normalizing its policy stance, I would argue that the risks are still too high. There are no signs of inflation, and expectations do not appear to be deanchoring. The ECB can afford the luxury of concentrating on ensuring growth. Although the Euro economy has behaved better than expected in the last year, this growth is far from self-sustainable as domestic demand is still very weak. Additionally, growth has been quite heterogeneous, driven primarily by Germany while others have been less dynamic. Not to speak of the periphery, still in the process of adjustment from the burst of the housing/financial bubble. Third, the necessary fiscal consolidation push, in a context of "still healing" financial sector, poses an additional threat to sustained growth in the short term that monetary policy should help alleviate. The central bank should also take into consideration the state of the financial/banking sector. The exposure of European banking to sovereign bonds still poses a risk to the real economy. Retiring its support policies too soon may be counterproductive and it may even lead to having to implement them once again in not too distant a future. Finally, the ECB cannot ignore the policies carried out by other central banks. The Fed's quantitative easing policy will have an impact on the Euro economy and its financial sector. Moreover, the Euro economy may be exposed to the same threats that are motivating the Fed to act.
Manuel Balmaseda is Chief Economist of CEMEX

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