The ECB is going to do some stuff to rescue the eurozone economy, big stuff, but it will tell you what, exactly, later, if it needs to. So relax.
Stuck with a Governing Council-approved tool box which is probably inadequate, but not, apparently, possessed of a firm agreement to turn “whatever it takes” into actual large-scale government bond buying, ECB President Mario Draghi temporized on Thursday.
Besides leaving interest rates unchanged and sitting back to let measures already underway take effect, Draghi did a reasonable job of appearing highly committed to further bold action but remaining vague on specifics, much less timing.
“The Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate,” Draghi said. That’s great but much hangs on the definition of “additional” or for that matter “mandate.”
“The Governing Council has tasked ECB staff and the relevant Eurosystem committees with ensuring the timely preparation of further measures to be implemented, if needed,” read the very next sentence.
Marc Ostwald, strategist at ADM Investor Services, was underwhelmed, writing to clients:
“In plain English, this says ‘we have an easing bias, but we have no idea at the moment what else we might do.’ If that is meant to be ‘forward guidance,’ then God help us all.”
But that is just it. This was meant to be forward guidance, which is, in itself, a pale and arguably self-defeating substitute for action. The eur zone is facing its third recession since the crash and, even worse, faces a non-negligible chance of seeing a self-reinforcing deflationary mindset take root.
Even forward guidance from a central bank like the Federal Reserve may fail to convince, because, after all, a steer of future action is not an obligation. From the ECB, with internal dissension, forward guidance will inevitably face a higher chance of diluted effect.
To be sure, the euro fell in what must have been a satisfying way after Draghi spoke, though eurozone equities failed to hold much of their gains.
Specifics, specifics
Reportedly facing pressure from colleagues on the Council over communications style, Draghi did deliver a united front on the expansion of the ECB’s balance sheet, in essence promising a target of €3trn, a trillion more than now.
Yet even when being admirably specific, Draghi is operating in a reality in which there are real limits on not only what he can promise, but how much of his promise the market can infer will be delivered.
“We are quite confident that the impact on our balance sheet size will be adequate, will be significant, will be sizable,” Draghi said. “The main message is that our balance sheet will keep expanding in the coming months and will continue expanding while the balance sheets of other central banks are bound to contract.”
All of that is highly debatable. Firstly, while the ECB will expand their balance sheet, no doubt, there are limits, given what is out there to buy, to what they can do short of outright government bond buying. It seems now possible that it will go beyond purchasing structured securities and begin to purchase corporate bonds. Again, though, the size and depth of the corporate bond market will impose limits on this, as will concerns about picking winners and losers.
Secondly, the idea that other central banks are “bound to contract” balance sheets is one of those things which will eventually be true, but perhaps not in a time scale helpful to the ECB. The Bank of Japan surely isn’t soon going to contract, and while this is helpful to risk assets, including Greek government bonds, it isn’t an unalloyed blessing to the eurozone.
The Fed, for its part, has no current plans to contract its balance sheet, choosing instead to replace maturing bonds with similar new ones. Any reduction in the size of the Fed’s balance sheet, either through a sale or passive roll-off, will probably only happen once the US central bank has successfully raised interest rates. That may only happen late next year, or be delayed further. The Fed may not be in a position to play along with its ECB-appointed role of making the euro look less attractive and counterbalancing the BOJ.
That the ECB was able to present a reasonably united front on Thursday is good, but its means of doing so revealed much about factors which, promises aside, weaken its hand.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication, he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
