The ECB, interest rates and QE: will they or won’t they?

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‘A committee can make a decision that is dumber than any of its members’ – David Coblitz 

Where are you going to be at 12.45pm London time on Thursday?  In this volatile period in financial markets, arguably the most important data point this week is the publication of the European Central Bank (ECB) interest rate decision. 

So, will they or won’t they cut interest rates or announce more QE?  A month ago in that ‘back to work’ period after the holiday season, the ECB held rates again at 0.25% so you’d be forgiven for thinking quite how much more they can cut!  Even a couple of weeks ago at the Davos World Economic Forum meeting, the talk was of how it was the first conference for five years without the backdrop of a crisis. Hubris and tempting fate eh? The sharp Argentine Peso devaluation changed that view…  And now, little more than two weeks later, august publications like the Financial Times are publishing stories with headlines like ‘consensus builds of an ECB rate cut’. 

What is going on here?  Well, to put it simply (and generously), the earlier views were a bit too optimistic.  Even putting the emerging markets volatility to one side, the world’s media forgot far too easily that it was only in November that the ECB surprised everyone and cut rates.  An organisation like the ECB, with its key inspiration being the severe anti-inflationary German Bundesbank, does not do things lightly.  Rates were previously cut because economic growth rates remain poor (even Germany has not grown more than 1% in either of the last two full years) and inflation remains low.  In Europe, in short, deflation risks are building as shown by the red and yellow areas in the below ‘traffic lights’ chart.

So the ECB committee sees the lack of inflation and cuts rates to say 10 basis points (0.1%) and/or undertakes some QE initiatives to get some stimulus into the local economy on Thursday, yes?

Well…unfortunately it is not that easy.  The behind-the-scenes story of the November interest rate cut was that the German representatives were against it.  Whilst the natural instinct might be that the Germans have played the spoilsport role in Europe for a few years now, take a look again at the ‘traffic lights’ chart above.  From a purely German perspective, maybe an interest rate reduction is not justified. 

Mario Draghi

Here’s the problem though, whilst the ECB is one country one vote, when Germany complains and disagrees, others follow including Mr Draghi the ECB President.  This morning a story was running in the press that:

‘European Central Bank President Mario Draghi would only consider ending the sterilization of crisis-era bond purchases if he’s openly backed by the Bundesbank, according to two euro-area central bank officials familiar with the debate’.

To put that into the clearest English, what this is saying is that QE is off the table until the German representatives agree.  Have they changed their minds since November?  Unfortunately I think not.

Germany will only agree to more support if the countries of central and southern Europe agree to big reforms to help reduce their deficits and improve their competitiveness – and hence reducing the likelihood that Germany will need to help bail out these economies to keep the Euro Zone going.  Have we seen such reforms?  Not enough.  And so a game of brinkmanship goes on…with the European economy in the middle. 

So there should be both a cut in interest rates and a resumption of QE in Europe to get the local economy going.  Will there be?  I don’t think so this time.  Hmmm, not good. 

Thank goodness some European companies generate a majority of their revenues outside Europe…

Written by Chris Bailey of

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