With few weeks to go before the end of his term, outgoing European Central Bank (ECB) President Mario Draghi left a lasting mark on monetary policy on Thursday. It is “whatever it takes” for “as long as it takes.”
Eurozone inflation is subdued to 1,2%, that is, well below the 2% target indicating a healthy economy. That is despite a tight labour market across in Western Europe and declining levels of unemployment in the south. Therefore, Draghi made three commitments Christine Lagarde will have to uphold for an indefinite period.
Draghi’s second term ends on October 31 but his legacy will be lasting.
Deposit rates will submerge further into negative territory by 10 basis points (-0,5%), which brings the number of Central Banks operating with negative interest rates to five, along with Switzerland, Denmark, Sweden, and Japan.
In addition, sovereign bond yields will continue to submerge in the 19-member eurozone, with the ECB announcing a fresh asset-buying program of €20 billion a month, starting in November 1, 2019.
More controversially, the ECB will introduce a mechanism designed to partially exempt banks from paying interest on excess cash deposited with the central bank, referred to as tiering. That will ease the cost commercial banks pay to park €1 of excess reserves by approximately €2bn a year.
Clearly, the new measures penalize savings and stimulate borrowing, in an effort to boost growth. That is a policy that does not enjoy consensus in the ECB’s 25-member board. The central bankers of Germany, Jens Weidmann, and The Netherlands, Klaas Knot, have made their disagreement a matter of public record. But France and Estonia are also said to have pushed back on the decision to renew quantitative easing, Reuters reports.
Objections are not only raised by central bankers.
The Dutch parliament sent a formal letter to the ECB on Wednesday, with lawmakers formally opposing quantitative “tiering” or preferentially high-interest rates offered on banks but not pension funds. The Dutch civil servants’ pension fund (ABP) alone has €451bn in assets that yield very little, resulting in pension cuts.
Another critic is President Donald Trump.
While recession in Europe is blamed on declining business confidence and a slowdown in global trade triggered by the Sino-America trade war, the US President is reacting vehement attacks on the ECB. On Thursday, Trump took to Twitter to accuse the ECB of currency manipulation.
“They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports…. And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!” Trump tweeted.
The eurozones’ labour market is tight and there was even marginal growth in consumer spending in the second quarter, to the tune of 0,2%. Still, the German economy is on the bring of a recession, with negative growth in the second quarter and projections of further and faster slowdown in the third. But German and Dutch savers continue to save.
However, there are signs that German budgetary policy may be changing. German bonds with maturity of up to 30 years offer negative yields. Low yields have decreased the cost of refinancing German debt, unleashing additional fiscal room for spending in the region of €1bn for 2019 and a projected €5bn for 2020.
Germany used to borrow €40bn a year in 2008 and now borrows €18,2bn. Some of these savings will cushion the slowdown of tax revenue as recession is looming. But at least some may also make its way back to the economy as public investment.
Draghi insists that a recession across the Eurozone is still a “small probability” but warns that monetary measures alone will not suffice. “Timely and effective action” is needed, with Draghi underscoring the need for governments to do more to stimulate growth. The message is clear: spend, spend, spend.