Yesterday was packed with news including some especially sad news from the UK, but I want to focus on what turned out to be a fascinating policy meeting at the European Central Bank or ECB. The news from there was significant well beyond the boundaries of both the Euro area and Europe as it signaled issues that are common to so many. Let us start with the basics.
The Governing Council decided to raise the three key ECB interest rates by 75 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 1.25%, 1.50% and 0.75% respectively, with effect from 14 September 2022.
Even such a simple statement covers a lot of ground. For example I have questioned in the past if the ECB can escape negative interest-rates? Well we have found a way it has been forced to with inflation at 9.1% although care is needed as supermassive black holes have a way of sucking you back in ( the event horizon). Also it has just equaled its largest ever rise with a 0.75% move ( there was a technical move as the Euro began).
The rationale for this comes with a really odd kicker if you include the sentence before.
As the current drivers of inflation fade over time and the normalisation of monetary policy works its way through to the economy and price-setting, inflation will come down. Looking ahead, ECB staff have significantly revised up their inflation projections and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.
So the interest-rate rise is in their terms in response to higher inflation expectations, Just after telling us inflation will come down! Actually they have spent the last year raising their inflation expectations after telling us it was transitory or as President Lagarde put it a “hump”. If we switch to some other news this week that sort of performance at Chelsea football club would have seen them sacked on several occasions.
The Precious! The Precious!
There was more because in spite of the fact that higher interest-rates are good for banks a central banker apparently cannot resist giving them some more sweeties.
Following the raising of the deposit facility rate to above zero, the two-tier system for the remuneration of excess reserves is no longer necessary.
So they get the Deposit Rate of 0.75% on their deposits but pay less than that on their TLTRO borrowing. In fact they were paid to borrow for a while.
In 2020-2021, European banks borrowed more than EUR 2 trillion (!) from the ECB via the so-called TLTRO operations. The borrowing conditions were extremely advantageous with interest rates as low as -1% for the Jun20-Jun22 period. ( @MacroAlf)
On average it looks as though they will make about 1.25%. Nice work if you can get it.
What can we expect next?
The international theme came firstly with the establishment of 0.75% being the standard for this series of moves ( are you listening Bank of England?). But there was more as we were guided to the future.
Based on our current assessment, over the next several meetings we expect to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.
Perhaps someone should invent a phrase for that like “Forward Guidance”. Except of course they have only just abandoned it before reincarnating it.
Plus we got some classics from President Lagarde.
Do I know exactly what is the terminal rate? No.
If it means that we have to go further than whatever rate you refer to, we will do so.
So she will go further than the interest-rate she does not know?
It gets better as we were told this.
because we will proceed meeting by meeting and on the basis of data……..and on the basis of the data that we receive.Our future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach……but if the data on our meeting-by-meeting review suggests that we should take a high hike of our interest rates, we will do so.
So it is the data until well see for yourselves.
I think what I understand that to be is that we cannot be purely mathematical.
So it now isn’t the data?
Then as we recall that Forward Guidance was abandoned only one meeting ago.
What we know is that we want to get to that 2% medium-term target, and we will take the necessary steps along the way in order to get there. We think that it will take several meetings. Some people will say, “How many is several?” Well, it’s probably more than two, including this one, but it’s probably also going to be less than five. Now, I leave it to you to decide whether it’s going to be two, three or four.
So between 2 and 5 is in fact actually between 1 and 4. Which is pretty wide and probably not the best to reveal. But having put it like that you then have really rather fenced yourself in for the October decision.
This morning the attempted clarifications ( a familiar feature of the Lagarde Presidency) are not really helping. Here is the head of the French central bank.
Villeroy has been among ECB officials providing estimates of the neutral rate. He doesn’t sound quite sure about it still. *VILLEROY: ECB DOESN’T YET KNOW TERMINAL RATE *VILLEROY: EURO AREA NEUTRAL RATE BELOW OR CLOSE TO 2% ( @fwred)
It does not help to throw in another theoretical construct especially if you are not sure what it is! Even worse it is unclear which interest-rate he is referring to which matters as the ECB ones differ by 0.5%. So the clarification muddies the water further.
My opinion is that he means the deposit rate which means he is suggesting at least 1% of further interest-rate hikes this year.
Villeroy says ECB should be at ‘neutral’ by year end ( @TradingFloorAudio)
This means at least two 0.5% interest-rate increases. But apparently.
ECB’S VILLEROY: NOBODY SHOULD SPECULATE ABOUT THE MAGNITUDE OF THE NEXT STEP, WE DID NOT CREATE A NEW JUMBO HABIT. ( @financialjuice )
He has just lit the blue touch paper on such speculation.
The Euro
Next up was this. We don’t
It will not surprise you if I say that of course we do not target any kind of exchange rate for the euro.
But we sort of do.
But of course we monitor very carefully and just like all of you, we have noted the depreciation of the euro relative to a basket of currencies but more importantly, relative to the dollar
Regular readers may recall that last time around President Lagarde hinted at an exchange-rate target.
Comment
I said at the beginning that there were shifts here way beyond the Euro area and there are two major ones. The first is that it has just set a benchmark for other central banks for the rest of 2022 and into 2023 ( technically February if you count the meetings). Interest-rates will be substantially higher ( over 2%).
Next up is that they have inadvertently revealed how confused and lost they are or as Genesis put it.
Oh, Superman, where are you nowWhen everything’s gone wrong somehow?The men of steel, the men of powerAre losing control by the hour
Of course in this instance we might say Supergirl. I recall when we were assured that they would have no trouble at all in controlling inflation whereas now they admit they do not know what will be required. On its own some humility with the implication of honesty is welcome. But this is not how it has played out as they have been forced out of their previous arrogance by events. That is very different.
Lastly we were assured that there would be no recession whereas now we are told.
ECB’S VILLEROY: WE CANNOT EXCLUDE A LIMITED RECESSION. ( @financialjuice)
We return to the point I frequently make about timing. Because they have got it wrong they are acting procyclically or tightening into a slowdown. We may yet see panic cuts in 2023 to complete the shambles.
The Queen
It is an extraordinary time in another way. All my like the UK and others have only had one monarch. Rest in Peace to her and thank you for a quite extraordinary reign.