The eurozone reported a flash reading of its October CPI today, the last
day of the month. After softer Spanish and German national reports,
it was not surprising that the headline eased to 1.4% from 1.5%. ECB
President Draghi has warned of some near-term softness due to energy prices.
The unexpected news was that the core rate slipped back to 0.9% from
1.1%. This matches the low from
May. The low this year and last was 0.7%, while the cyclical low was
0.6%.
To be sure, the ECB does not formally target the core rate. Nevertheless,
it is operationally clear that it matters to policymakers. It helps
inform the judgment that inflation is not yet on a sustainable path toward the
target, and is the primary reason why the ECB seemed unanimous in extending it
asset purchases well into next year.
Draghi suggested that there was some disagreement on whether to leave the
purchases open-ended or announce, that barring some new shock, an end
date. A newswire reported that
there might have been five dissents from
the decision to keep it open-ended. This group of five represents the
hawkish wing of the central bank. It appears to be composed of central
bankers from Austria, Estonia, the Netherlands, and, of course, Germany.
What is the difference between saying that the ECB intends to complete
its purchases in September and saying simply the
recalibration commitment runs to the end of next September?
Strategic ambiguity. This is a
concept from game theory. Sometimes
it may make sense to be clear, transparent and unambiguous. However,
those values are contextual and not moral
or ideological. They are tactics.
There are many times when being less clear and less obvious allows one to
maximize the degrees of freedom and keep adversaries on edge. There
are numerous examples of this, such a the US refusal to rule out first use of
nuclear weapons or Israel’s reluctant to admit it has nuclear capability.
This is to recognize that sometimes
having an adversary be certain how one would respond may act as a
deterrent. On the other hand, making the adversary uncertain how one
would respond also may have advantages.
It is difficult to test counter-factual claims, so let’s begin with what
has happened since the ECB’s meeting last week. Ten-year German and
French yields have fallen 13-15 bp, while the yield on Italy’s benchmark is off
25 bp and Spain’s is off 19 bp. There have been some other considerations
that may have aided Italy, like S&P’s unexpected upgrade before the
weekend, and Spain, like the seeming end of the
Catalan secessionist drive. If the dissents had carried the vote and a
hard end date was provided, would yields
have eased as much?
There is no need to pre-commit. The open-ended nature of the
purchases maximizes the flexibility of
decision-makers. That was the basis of our argument last month that the
ECB would reduce its purchases to 30 bln from 60 bln, while the consensus was
for a move to 40 bln euros. Our
judgment was based on flexibility rather
than a supposed shortage of securities, which Draghi continues to deny to
reporters who seem to question him after every meeting. The question has
not changed, and neither have the answers.
Is tapering in Q4 18 from 30 bln a month to zero the difference between
competent and incompetent management of monetary policy? If buying more than 2 trillion euro of assets
produced a certain response would topping it off with say another 60 bln euros
make a significant difference? We answer both questions in the
negative.
Nevertheless, the dissent is important. First, it offers a
crystallization of a hawkish wing at the ECB. They are the usual suspects
(Germany, Austria, and the Netherlands). Hansson (from Estonia) comments had
also shown his leanings. There may be a one or two others that might side
with the hawks but disagreed on this
particular tactical issue. In the current environment, the hawks are a minority, but one whose power and influence is arguably greater
than its numbers.
Second, the dissents may not have been so much about the tactics of
tapering. The dissents were a proverbial shot across the bow.
It was a warning of the post-QE struggle for the soul of the ECB. Will it
revert back to the Bundesbank’s
ordoliberalism, which Draghi said is part of the central bank’s DNA? Or
given the TLTROs that will be outstanding for several years, open-ended
reinvestment of maturing proceeds, and the sheer size of the ECB’s balance sheet has the ECB’s DNA changed?
There has been much focus on the pending significant changes of personnel
at the Federal Reserve’s Board of Governors. Similar and profound changes are coming to the ECB, but they are
more stretched out in time than the changes at the Fed. In the middle of
next year, the vice president’s term ends. The choice here could
paradoxically influence that the succession of President Draghi in 2019.
Also, in 2019 Praet’s and Coeure’s terms on the executive board of the ECB’s
end. That means in the four of the six executive board members will be
replaced in 2018 and 2019.
Speculation of Draghi’s successor has already begun. The
Bundesbank’s Weidmann is an obvious candidate. However, he has proven
divisive and has testified against the ECB before the European Court of
Justice. The ECB President must be a consensus builder, and it is not
clear that Weidmann is up to the task. He has vigorously defended the
Bundesbank, but even the German government reportedly did not support his
appearance before the ECJ.
And thinking again about the counter-factual, the history of this period
could have been markedly different if Germany’s Weber had succeeded Trichet as
ECB President instead of quitting after losing a vote. Germany’s
Stark also resign then, and he may have been a candidate to succeed
Draghi. There does seem to be a way to square the circle: have a
German at the ECB who is not a doctrinaire
defender of the interests of the creditors. Praet, the chief economist at
the ECB, hails
from Germany and is regarded as more of a
team player. Some may object based on age, but this is not
necessarily a deal breaker. We note that BOJ’s Kuroda, who may be given a second term, and Yellen, who is said
to be under consideration of a second term are a little older than Praet.