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Last week’s press conference by ECB President Mario Draghi left the markets disappointed and somewhat perplexed about the shift towards quantitative easing that had just been sanctioned by the governing council (GC). Because this was focused on private sector assets, in the form of asset backed securities and covered bonds, there were doubts about whether the new policy could be implemented in sufficient size to deal with the deflationary threat in the euro area.
Mr Draghi was noticeably hesitant about giving any firm indication about the likely scale of the programme. Although private sector quantitative easing (QE) is likely to suit the needs of the euro area rather well, as I argued here, the absence of any firm guidance on scale certainly undermined the beneficial announcement effects of the policy change.
The ECB president addressed this issue on Thursday in an appearance at Brookings in Washington. This time, freed from the need to speak for the entire GC, he clearly changed his tune on the scale of the programme. But this highlighted the extent of the gap between his view and that of Bundesbank President Jens Weidmann, who presented his position in a revealing interview with the Wall Street Journal on Monday. It is far from obvious how this disagreement will be bridged. Read more
The initials LTRO, barely ever discussed prior to last December, now form the most revered acronym in the financial markets. Before the first of the ECB’s two Longer Term Refinancing Operations in December, global equity markets lived in fear of widespread bankruptcies in the eurozone financial sector. Since LTRO I was completed on December 21, equities have not only become far less volatile, but have also risen by 11 per cent.
With LTRO II completed last week, over €1tn of liquidity has been injected into the eurozone’s financial system. Private banks were permitted to bid for any amount of liquidity they wanted, the collateral required was defined in the most liberal possible way, and the loans will not fall due for three years. Any bank that might need funds before 2015 should have participated to the hilt, thus eliminating bankruptcy risk fora long time time to come. Read more
Jens Weidmann, Bundesbank president. (c) Tim Wegner
There was a time, before the existence of the euro, when the financial markets hung on every syllable uttered by the president of the Bundesbank. Not only was the German central bank the most respected institution in global finance, it was a founder member of the awkward squad, and was frequently willing to stare down politicians, no matter what the temporary costs in market turbulence. Macro traders, who were routinely dismissive of public officials throughout the world, never found that it paid to be dismissive of the Bundesbank.
Since monetary union, the Bundesbank has lost some of its lustre, which is inevitable given that its president now has only a single vote on the ECB’s 23-member governing council, the same as the head of the central bank of Cyprus. However, this week it has been just like old times, with Jens Weidmann, president of the Bundesbank, setting the entire agenda for the financial markets with his FT interview on November 13, in which he appeared to torpedo hopes that ECB bond buying would soon become open ended in order to support the new government in Italy. Mr Weidmann not only argued that such buying would be inadvisable, he went as far as to claim that an unlimited extension of the SMP to hold down bond yields would be illegal, which is another matter entirely. Read more
The behaviour of the world’s two main central banks, and the relationship between them, have profound effects on global financial markets. As a broad rule of thumb, the ECB (and the Bundesbank before it) have tended to act in a very similar manner to the Fed, except about 6-12 months later. In fact, that is one of the most well established rules in the analysis of monetary policy making.
It does not imply that the ECB deliberately “copies” the Fed, which it clearly does not do. But it does imply that circumstances have usually produced this symbiotic relationship between the two key central banks. When this relationship has been broken in the past, it has usually spelled trouble. Read more