A ‘red October’ (at least on paper) has put the ECB into panic mode. The monetary policy of the European Central Bank (ECB) has given a surprising turn in recent weeks. As if it had suddenly seen something very dangerous on the road and with a certain impression of trying to right a mistake (like the one in 2011 when it raised rates with a moribund economy), the ECB is once again opening the way to an era of cuts of rates that could take the price of money even below the neutral level (that consistent with full employment and inflation on target). Behind this striking flashbackthere may be some psychoanalysis: it seems that at the ECB no one wants to go down in history for having done too little to keep the economy and the single currency alive. Nobody wants to become the new Trichet. However, when you look back and look at the ‘real’ data published to date in isolation, you can see an idyllic scenario, a macro ‘framework’ that Lagarde would not have imagined even in her wildest dreams a year ago. : inflation hovering around 2%, GDP growing moderately by 0.4%, a strong labor market and wages slowing. However, the ECB is in panic mode.
To understand the current context, it is crucial to remember how in 2011under the presidency of Jean-Claude Trichet, the ECB raised the reference interest rate by 25 basis points for two consecutive quarters, reaching 1.5% and generating a critical situation that almost disintegrated the euro zone. The error, on top of that, came after 2008, when the Eurobank raised rates just before the mortgage crisis subprime of the US will lead to the bankruptcy of Lehman Brothers and the world we knew will change forever.
After the 2011 error, the ECB tried to correct the error with a historic battery of cuts and the launch of several stimulus programs (bond purchases to inject liquidity) that would prevent the breakup of the euro, but that would forever change the functioning of the monetary policy and the European financial system. For history will remain the phrase of the greatest exponent of this ‘correction’ in a big way: the “whatever it takes“(“whatever it takes”) Mario Draghi.
Carsten Brzeski, Global Head of Macro at ING, notes in a recent note that “the ECB has made a notable shift towards a more lax policy.” The decision to reduce interest rates in October was justified, as explained by the president of the ECB, Christine Lagarde, under the argument that disinflation was gaining strength, which allowed the organization to act without excessive pressure. However, Brzeski believes that comments from some ECB members this week “clearly show that what seemed like a balanced decision to gradually reduce the level of monetary policy tightening is currently turning into a panic about rushing to reach a neutral stance as quickly as possible“.
The bad data for October (some disastrous PMIs) and the fall in oil have opened the doors for the ECB to unleash an era of cuts in the style of Mario Draghi, former president of the ECB, known for making monetary policy more flexible beyond the limits. ‘natural’ limits to save the eurozone. Although the ECB now seems willing to undertake a similar race, the truth is that inflation is close to the target, GDP is growing little, but growing, and the labor market is in great health. In 2012, the eurozone was in recession and the labor market was ‘in a mess’.
Now, the fear that the euro zone will fall into a recession, dragged down by Germany and its industrial sector, with France also showing anemia, is taking over an ECB that could now take rates up to 1.5% quickly and forcefully. A level noticeably lower than expected until recently. With increasingly pyrrhic growth (especially when compared to that of the ‘American friend’), oil in free fall and disinflation gaining strength, it seems that the central bank prefer to go too long (cutting back) than to fall short (keeping rates in restrictive territory) and end up being remembered, once again, as the culprit of another major crisis in the euro zone.
Although official data do not yet justify a major revision of macroeconomic projections, the fear of prolonged stagnation has regained prominence within the central bank. As Brzeski points out, “this new pessimism must respond to an increasingly clear perception that the economy is trapped again in a structural weakness“.
The truth is that the recent slowdown in inflation has been driven, in part, by temporary factors such as the fall in energy prices, while underlying inflation, especially in services, remains high, which still gives some hope. ammunition to the falcons. But the flat graph on the screen of vital signs of growth in a world that does not stop moving and becoming dynamic (The US and China are the two great ‘poles’ when talking about competitiveness) has brought back fear and, to a certain extent, guilt.
ING: “Suddenly, it seems that the ECB has returned to the 2010s”
The background speech demonstrates it. For example, it is interesting that, unlike in recent times, the ECB has stopped emphasizing structural factors that could be raising long-term inflation. “What happened to the arguments about green inflation or the demographic impact and the globalization” asks Brzeski, recalling that until recently the ECB maintained that these structural factors exerted upward pressure on prices. “What has happened to the old discourse of central bankers that monetary policy cannot solve the problems “structural problems of an economy?” is also asked based on comments made by officials not so long ago. “Suddenly, it seems that the ECB has returned to the 2010s”sentence.
“The ECB now appears determined to get ahead of the trend and return interest rates to a neutral level as soon as possible. For supporters of the stance dovish or accommodative, this is a no-brainer, and for the hawks, the argument could be that getting rates back to a neutral level quickly could be enough to avoid another episode of unconventional monetary policy with quantitative easing and negative interest rates later,” resolves the ING strategist.
Expanding the previous definition a little further, the neutral type The one that analysts refer to is defined as that which “balances the aggregate demand of an economy with its aggregate supply”, according to the economists at CaixaBank Research. In other words, according to these same experts, the interest rate set by the central bank that “would allow the economy to operate at full employment and with price stability.” The ECB’s calculations place the neutral real interest rate close to 0%. So, if inflation remains at current levels, the Eurobank should keep its rates close to 2% (the nominal neutral rate) compared to the current ones, even above 3%.
If disinflation continues and economic weakness hits harder, the ECB would be in the position of leaving official rates still below this mark. If the market has already begun to buy this thesis, betting on a terminal rate (the last of the downward cycle) of 1.75%, analysts go even further. Mathieu Savary, chief strategist of BCA Researchthe season already opened a few weeks ago in elEconomista.es by contemplating a terminal rate between 1% and 1.5%.
Capital Economics: “In this context, the mood in the Governing Council of the ECB has already darkened”
Now, other analysis houses such as Capital Economics. “In light of the worsening outlook for economic growth and inflation in the eurozone, we are making significant downward revisions to our ECB interest rate forecast. We now believe that the central bank will implement consecutive cuts of 50 basis points in December and January, and will reduce the deposit rate to 1.5% by mid-2025,” says Jack Allen-Reynolds, the firm’s deputy chief economist for the euro zone.
“It is difficult to foresee a substantial improvement in growth next year. consumers have been reluctant to increase spending, despite rising purchasing power, and it is likely that real income will slow down next year. Furthermore, the investment plans of companies are moderate because the manufacturing sector faces major structural problems and governments are increasingly tightening fiscal policyeven as their economies slow down. As protectionism is likely to increase and the eurozone will lose competitivenessit seems unlikely that there will be a rapid recovery of the exports“, summarizes the expert in a devastating paragraph of his note to clients.
At the same time, they continue from Capital Economics, the labor market is easing and wage growth is slowing. The unemployment rate is now at a record low, but economists suspect that this partly reflects a fall from its equilibrium level. The reality is that the vacancy rate has decreased greatly over the past two years and the proportion of companies reporting labor shortages has decreased. At the same time, surveys of companies’ hiring intentions point to a further cooling of labor demand in the future. “In this context, The mood in the Governing Council of the ECB has already darkened“, certifies Allen-Reynolds. In the end, this abrupt ‘awakening’ of the ECB a decade ago makes some sense.
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