ECB Stimulus Ahead (audio available)

Forget the Fed!!  ECB Stimulus Ahead…Finally!

While the FOMC took center stage in the news last week, we can not ignore important comments from the ECB. The ECB President, Mario Draghi, hinted that “additional stimulus will be required,” if the European economy does not improve. They also noted that they have a “wide range” of tools to boost the economy. This is important because it looks like we will be entering another period of coordinated central bank easing. We want to outline the rationale behind the need for stimulus in Europe. In addition, with their benchmark rate deeply in negative territory, what some of the tools they may have at their disposal to prop up growth.

There were signs that the European economy was stabilizing earlier this year, however recent data has shown the economy is weakening. The ECB has one mandate, not two like the Federal Reserve, which is to keep prices stable. This compares to the Federal Reserve’s dual mandate to keep prices stable and maintain full employment. Below we highlight some of the factors that justify the ECB considering another round of stimulus.

  • Manufacturing: The Eurozone PMI has been in contraction territory for the past four consecutive months. Of the top 10 economies in the EU, six of them have manufacturing PMI levels that are in contraction territory (below 50). In addition, seven of the 10 have seen their PMIs falling since the end of 2018.
  • Global weakness showing in new orders: Germany alone, is the third largest exporter in the world and the biggest in the European Union. Of the countries that Germany exports to, France and China are the second and third biggest importer, respectively. Therefore, the slowdown in Europe and China’s economic growth is weighing on the orders data from the EU as a whole (Germany is biggest exporter). On a year over year basis, industrial new orders have fallen for the past six consecutive months. That is the worst consecutive streak of weakness in orders since 2012-2013.
  • Consumers a concern: Eurozone retail sales have weakened in recent months and actually declined in April for the first time in four months. In addition, the European Commission Consumer Confidence Indicators has persistently been in negative territory. Lastly, we like to look at auto registrations as a gauge for the consumer and EU new passenger car registrations have fallen for eight of the past nine months.
  • Banking fears: EU banks have struggled due to slower global growth, a zero interest rate policy, burdensome debt levels and corruption. The ECB has had to rescue one Italian bank in 2019 and the IMF has urged German banks to “accelerate restructuring.” Rate cuts could further hamper European financials so the ECB will have to offer stimulus for the banking sector as well.
  • Stubbornly low inflation: According to the ECB their inflation mandate is ~2% over the medium term. However, core EU CPI has not grown by 2% (YoY) since March 2008. Even over the past five years, the average CPI core has only grown 1.0%. In addition, the top five European countries (ex the UK) have seen their year over year growth rate in CPI fall, by on average, 0.50%. The only exception is the Netherlands which has seen inflation increase.
  • What “tools” are left? With the EU economy already in a zero interest rate policy, the question remains what “tools” does the central bank have left at their disposal.
    TLTRO: Another targeted long term refinancing operation (ECB offers incentive to banks to lend through low cost, longer-term loans from the ECB) is an option. The first program was in 2014 and another in 2016. This helped to boost the average YoY growth go from contracting in 2013 to growing 1.3% (YoY) in 2014. In 2016, growth improved from 1.8% to 2.5% in 2017.
    Cut rates: However, with rates already in negative territory there is speculation on the positive impact this can have without additional measures taken.
    QE: The bank can outright buy government bonds from banks but this is likely a last resort due to the necessary changes to European law on the amount of a countries debt the ECB can own.