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It’s Those Darn Hawks Again – Klaas Knot Makes An Unwelcome Cameo

Keeping the (non-existent) powder dry.

In news that isn’t exactly surprising, ECB hawk Klaas Knot isn’t on board with the idea of restarting net asset purchases right now.

“If deflation risks come back on the agenda then I think the asset-purchase program is the appropriate instrument to be activated, but there is no need for it in my reading of the inflation outlook right now”, Knot said Thursday, according to comments from Amsterdam carried by Bloomberg.

To be clear, the inflation outlook in Europe isn’t what one would call “inspiring”. Expectations have collapsed and delivered inflation isn’t even close to target. In fact, euro-area inflation was revised lower for July earlier this month. In the second revision, the headline print moved down a notch to 1% YoY from the 1.1% reported at the end of last month. A fresh read due this week isn’t expected to be any better.

Knot’s predictable opposition to more QE came with a caveat – namely, that he’d support a rate cut. His comments come on the heels of equally predictable remarks from Jens Weidmann, who last week suggested the central bank shouldn’t “act for action’s sake”.

The ECB’s July statement laid the groundwork for the delivery of an easing package in September, including allusions to QE and tiering, something else Knot is apparently reluctant to countenance.

Growth in the eurozone broadly decelerated in the second quarter, and Germany is one quarterly contraction away from a technical recession. Details out this week showed the trade war weighed heavily on the world’s fourth-largest economy.

Markets generally expect the ECB to deliver a package of measures next month, and “merely” cutting rates further into negative territory likely won’t appease anyone. The ECB’s Muller and Olli Rehn have stoked speculation that the Governing Council will over-deliver.

In a sweeping assessment out Wednesday, SocGen predicted the September meeting will, in fact, deliver on expectations. Here are a couple of excerpts from the executive summary of the bank’s piece:

We now expect an open-ended €40bn/month QE programme to be added to a deposit rate cut of 20bp and tiering at the 12 September meeting. A generous tiering structure could surprise markets while helping to avoid banks applying negative rates for retail clients. More problematic, as in the past, will be how to end QE – given our views on the US economy next year, we see little chance of this happening before March 2021. Will it work? We doubt it. Even with fiscal support, potential growth is weak and policy multipliers impaired, but the ECB has little choice other than to defend its target credibility. The main impact should be on domestic confidence, allowing the current favourable credit trends to persist, while the industrial sector outlook depends on factors beyond the ECB’s control. Looking ahead, the ECB’s policy room is likely to dwindle further while high asset valuations risk deeper future recessions. A brave new world of negative rates awaits.

SocGen says that in the future, the ECB will likely have to ponder its own version of yield-curve control, more generous TLTROs and, yes, stock purchases. To wit:

Open an equity purchase programme (amounting to about €10bn/month). We would see more need for such a programme if stock markets were to become very volatile or fell so much that they constitute a risk to the real economy recovery. Ironically, the ECB’s efforts to stabilise asset prices in such conditions could mainly be motivated by financial stability, a problem the ECB itself has contributed to by its previous QE programmes.

All of this comes just months ahead of Christine Lagarde taking the reins. Whatever the central bank does now will raise the stakes for her in terms of communicating with markets and building consensus internally going forward.

Getting back to Knot, he told Bloomberg on Thursday that “not reactivating the asset-purchase program also means you keep some powder dry for when future contingencies actually happen”.

Two things there. First, there is no “dry powder” – not really. The balance sheet is bloated and rates are already negative, so what’s the difference if Draghi wants to cut another 20bps and buy some more bonds? Second, the “future contingencies” are already here. The outlook is the worst it’s been since the eurozone debt crisis. Japanification has arrived in Europe – they might as well just embrace it.


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