The Eurozone economy is a long way from being healthy, so it’s understandable that the market remains inclined to believe in more ECB easing at the March 10 meeting. I’m not going to go too far into the details of what the market expects, but a rate cut of 10bp or more and an increase in QE both now seem pretty much expected, along with possible tiering of deposit rates to limit the impact on banks. Of course, last time market went in with this expectation is got a bloody nose, with the ECB only producing a 10bp cut in the deposit rate in December, so positioning is likely to be a little more cautious this time around. But the ECB do seem less likely to disappoint the market this time, both because of less committed market expectations and because Mr Draghi will be very conscious of the risks of a EUR rally if he fails to produce a significant easing.
But while that may be what they will do, I’m not at all sure it’s what they should do. The ECB’s behaviour is looking to me to be increasingly overactive and is starting to look panicky, which seems to me to be creating rather than relieving concerns about the economy. It’s true that here has been a manufacturing slowdown since the last meeting, but no more so than elsewhere – indeed rather less so than in the US. PMIs have dipped but still indicate slow growth – we are not back in recession. Inflation is a little lower than expected or desired, especially the latest February number, but inflation can be quite volatile on a month to month basis and it is rash to make major policy decisions based on one month’s number. After all, while the market was disappointed by December’s easing, it is still the case that the ECB did ease as recently as December. Two easings in 3 monthswould suggest some need to panic, and I don’t think that’s a story the ECB should be telling. While they eased twice in 3 months in 2014, it was against the background of a very strong exchange rate. This time around, they have a weak exchange rate and inflation is being significantly subdued by a weak oil price. Core inflation dropped to 0.7% in February, but was 1% in January which was above where it was when they eased in 2014.That monetary conditions are being eased further even though the outlook looks better than in the past may reflect policy having bee too tight for too long, but this perma-easy stance with a hair trigger for further easing carries its dangers.
Firstly, there seems little reason to believe that a further ECB easing will have any significant impact. The ECB themselves indicate that loan growth is improving already and the pass through from any further exchange rate weakness is unlikely to be very large given the weakness of emerging market currencies. What the region could do with is an expansion of fiscal policy from those that can afford it (Germany). A modest deposit rate cut, especially if it is tiered to protect banks (and by implication savings rates) will have minimal impact. Secondly, the ECB seems to me to be underestimating the value of promoting confidence. A more upbeat assessment of the economy and an indication that they have some belief that the (substantial) policy measures already put in place were taking effect and would continue to take effect in the coming months would have a more positive impact. Gloom and doom and a further monetary easing both undermines confidence and takes the pressure off government to do anything on the fiscal side.
None of this means the ECB won’t ease next week. Indeed, the risk of market disappointment now means they probably need to given the expectations that have built up, in large part because of ECB rhetoric. But it would sensible if this time around Draghi emphasised some of the positives rather than indicating the potential for further action. Sensible because he is probably not going to be able to squeeze anything more out of the hawks on the committee anyway, unless there is clear evidence of a dive into recession, and even if he could it would be unlikely to have much impact. An attempt to build some confidence and perhaps encourage governments to take their share of the burden would, I think, be more effective than threats of ever more negative rates.