Fixed Income Research & Macro Strategy (FIRMS) – 10 July 2019

  • European Central Bank President Mario Draghi will step down at the end of his eight-year term on 31 October.  Christine Lagarde, the head of the IMF – which has implicitly called for looser global monetary policy – will take over pending European Parliamentary approval.
  • The ECB’s dovish turn at its 6th June policy meeting, Draghi’s talk of possible monetary policy easing and Lagarde’s nomination (announced on 2nd July) have contributed to the 0.7% depreciation in the Euro Nominal Effective Exchange Rate (NEER) to a two-month low.
  • Within the context of the ECB’s broad mandate “to maintain price stability, i.e. to safeguard the value of the euro” – Draghi deserves praise.  The Euro has been one of the most stable major currencies since November 2011, with the NEER in a narrow 17.3% range comparable to the managed Singapore Dollar’s (13%) and far narrower than the US Dollar and Japanese Yen ranges of, respectively, 32.4% and 54% (see Figure 3).

NEER since Oct 2011

  • However, Draghi has failed to meet the ECB’s primary monetary policy objective of “maintaining price stability with an inflation target of below, but close to, 2% over the medium term”. Eurozone headline and core CPI-inflation have averaged only 1.2% yoy since November 2011, well below the ECB’s target, despite the ECB having cut policy rates to record lows and asset purchases, which ended in December, totalling €2.6trn. Moreover, since Q1 2012, average GDP growth in the Eurozone (0.33% qoq) has lagged growth in other major economies, including the UK (0.50%) and US (0.58%).
  • We partly attribute this inflation under-shoot and growth underperformance to the late start of the ECB’s Quantitative Easing (QE) program in March 2015, by which time bearish inflation expectations were well entrenched (see “European Central Bank QE: A little late to the party”, 8 January 2015). While bond purchases by the ECB, Fed and Bank of England all amounted to about 20% of GDP, they started six years earlier in the US and UK where core inflation has averaged 2.0% since November 2011.
  • Whether or not Draghi cuts ECB policy rates and/or re-starts QE in the next three months, we expect the Euro to remain range-bound. But, as we argued in 2015, Eurozone inflation and growth are likely to underwhelm without wholesale structural and fiscal reform.

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Ryan Littlestone

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