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Bailing out the titanic with a teaspoon or why hope is a strategy for the ECB

The European Central Bank (ECB) meeting today was anticipated by investors with a range of expectations across the market from the hopeful to the pessimistic. With market-implied medium term inflation expectations close to all-time lows, Draghi’s reputation as the ‘man who can’ in Europe is on the line.

With rates already negative and QE finished, the ECB’s tool box appears to be close to empty. Mario Draghi, the mercurial central bank president who ‘saved’ Europe back in 2012 has a reputation for finding ways to provide additional accommodation to the European economy where others lesser central bankers would struggle.

However, today’s meeting effectively marks the beginning of the end of Draghi’s reign. Actual ECB policy actions were modest and the ECB forecasts are based more on hope than experience. His term finishes in November, he may now be a lame duck central bank president, unable to ram through policies that do not carry the full support of the governing council; a hallmark of his 8 year tenure.

The ECB delivered further accommodation today, adjusting its forward guidance a further six months into the future. It assured the markets that rates would not go up at least until the second half of 2020. The credibility of this forward guidance and its impact on the market can be questioned as markets assume a higher probability of the ECB cutting rates over this time period; so much for reigning in rampant market expectations for imminent hikes.

TLTROS

The ECB also provided additional detail on its recently announced Targeted Long Term Refinancing Operations (TLTROs). These details were marginally more accommodative than expected, however, these operations replace existing operations that were both longer in term and cheaper in price; hardly the big stick to persuade Europeans and market participants alike that the ECB up for a fight.

Draghi expressed confidence in the resilience in the European economy, but optimism and perennially inaccurate inflation forecasts will not be enough to re-anchor the markets inflation expectations, nor engineer a dynamic European economy. References, to a symmetrical inflation target and the possibility of cutting rates further and restarting asset purchases in his Q&A sound good, but mask the scale of opposition from various parts of the governing council to such proposals.

The ECB has always been a central bank with one arm tied behind its back due to the lack of flexibility in its mandate, the lack of cohesion of its governing council and the limitations of its ‘toolbox’. With Draghi on his way out, an empty tool box and weakening global growth, the ECBs task increasingly has the appearance of bailing out the titanic with a teaspoon.

For investors, negative yields and flatter curves and quite possibly a stronger Euro all appear to be on the cards and with it an economy that is increasingly moribund.

Andrew Mulliner 11 June
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