ECB policy is tightening – has been for some time
Update: Nouriel Roubini front pages this post on Euromonitor here.
The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.
Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.
But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).
It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis!
(read more after the jump!)
First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.
The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).
Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.
Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.
I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.
The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!
“But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed.”
Is the ECB pursuing a Germanocentric policy?
In any event, isn’t the prognosis for Europe pretty bad?
And wont’ that be bad for the US? And maybe Asia?
I beieve the answers are Yes, Yes, and Yes.
I would say that the ECB is definitely pursuing a policy more geared toward Germany (and France and Itally, too – but since Germany and France are the largest, we’re talking about them driving ‘average’ inflation). Thesw countries, especially Germany, are prime candidates for the pass through of headline inflation into wage contracts is Germany (and I reiterate may because there’s no evidence of pass through at this time).
Yes, I would say that the prognosis is bad, but that depends on how you define bad. Some bloggers – like Kantoos and David Beckworth – are arguing that monetary policy is too tight for even Germany. For the Periphery, it’s definitely bad. Think about this, too: the Periphery (Spain, for example) have predominantly variable-rate mortgages – the core are more fixed.
I’m not seeing how this is bad for Asia or the US. Europe is deriving a lot of its growth impetus from Asia AND the US (at this point in time – Germany is running a larger trade surplus against the US in 2010 over 2009). Slowing Asia would likely hurt Europe much more than slowing Europe would hurt Asia. As long as US growth is O.K., all else equal, Asia will be ‘fine’. Germany does run trade deficits against China, though.
These are great discussion points! Rebecca
PK weighs in again:
Euro Divergence (Slightly Wonkish) A daunting task, made worse by the ECB. (explains chart auf deutsch)
Thanks, jazzbumpa and Rebecca. 🙂
My concern about the US comes from the fact that, with the stimulus drying up, if Europe tanks we lose a lot of customers, don’t we?