Minutes from the contentious September ECB meeting show some policymakers wanted a 20bp rate cut, but no restart to net asset purchases.
That, in and of itself, isn’t particularly surprising. Ahead of the meeting, a bevy of officials told the media that they harbored serious reservations about restarting QE, but would support cutting rates further into negative territory. The market had, understandably, come to expect the relaunch of asset purchases given that the July statement clearly telegraphed the delivery of a comprehensive package of measures in September, and one way to avoid wrong-footing those expectations in the event QE wasn’t restarted would have been to overdeliver on the rate cut side of things.
What’s a bit more interesting is that some policymakers weren’t able to support a rate cut. Here’s the key passage:
While a few members expressed a readiness to consider lowering the rate on the deposit facility by 20 basis points at the current meeting, in particular as part of a package that would exclude net asset purchases, other members felt unable to support a cut of 10 basis points, as they were concerned about the possibility of increasingly adverse side effects from additional rate cuts.
The discussion around tiering sounds as though it was somewhat fraught as well. The account of the meeting says “a number of reservations” were lodged as officials pushed back on the two-tier scheme.
“It was argued that, at the current juncture, monetary policy transmission channels seemed to be functioning well [and] banks would benefit from TLTRO III, which offered them very favourable lending conditions, and from a significant decline in bank bond yields”, the minutes read. “A remark was made that providing partial relief only to banks for the costs of negative rates raised potential distributional and communication challenges”.
Perhaps most notable of all is the discussion around the open-ended nature of QE (i.e., “QE Infinity”, subject only to capital key restraints which, political considerations aside, are self-imposed).
“A remark was made that an open-ended announcement of renewed net asset purchases could give rise to demands by market participants for higher monthly purchase amounts, at least in the absence of convincing evidence of an improving inflation outlook”, the minutes read.
In other words, at least one policymaker (and probably more than one) suggested that making the new QE program open-ended and basing the restart of net asset purchases in part on a desire to convey a resolute attitude towards engineering “better” inflation outcomes, opens the door to a scenario where, if inflation (realized or expected) does not rebound, market participants will ask why the purchases aren’t being ramped up.
Of course, if purchases were ramped up, that raises the specter of hitting the limits under the existing structural framework for ECB QE.
“This would exhaust the purchasable universe and call into question the programme limits, which were considered important to ensure that the boundary between monetary policy and fiscal policy was not blurred”, the minutes read, recapping objections voiced by dissenters.
In the post-meeting press conference, Mario Draghi reminded everyone that the ECB has considerable headroom under the existing parameters.
“Our calculations show that, at this slow pace of purchases, ECB can continue APP at least until mid-2022 with limited capital key deviations”, UBS wrote in their postmortem last month, adding that “we have long believed that ECB has headroom to implement APP without increasing issuer limits right away”. Here’s a bit more:
Given the low monthly run-rate, we think it is likely that the share of PSPP would be around 75% with the rest distributed between other programmes. This would be similar to the pattern seen in 2018 when the monthly pace of purchases was EUR30bn for the first 9 months and then EUR15bn for 3 months before QE ended (Figure 1). Assuming the share of Supranational in PSPP stays at 10%, this would imply ~EUR13-14bn/month in sovereign, agency and regional purchases.
Feeding these numbers into our issuer limit calculations, we find that the openended programme can run comfortably at least until mid-2022 by when ECB will be close to hitting issuer limits in a few countries (Figure 2)
This is where it gets really interesting in the context of ongoing calls for fiscal stimulus.
“However, it was noted that, at €20 billion per month, the pace of purchases was far less than in earlier phases of the programme, while the current expansionary stance of fiscal policy would allow the Governing Council to continue purchases under the current limits for a significant period of time”, the account of the meeting says, detailing the counterarguments from those in favor of more QE. “Hence, it was felt that a discussion of the limits could wait until the issue became more pressing”.
That is essentially the doves arguing that as long as fiscal policy is some semblance of expansionary (and ideally, much more so), the supply of eligible bonds will increase, thereby alleviating some of the ostensible limits associated with the QE parameters.
“The restart of APP will create fiscal space for Euro area sovereigns”, UBS remarked, in the same September note cited above. “Our initial supply estimates for 2020 suggest that PSPP adjusted net supply will decline to ~EUR70bn from ~EUR185bn in 2019”.
This speaks directly to something BofA’s Barnaby Martin has spent quite a bit of time discussing of late. One “overlooked” aspect of QE is the way in which it “‘transforms’ sovereign debt-to-GDP ratios by moving bonds from risk-averse investors towards more risk-tolerant central banks”, he wrote, in a pair of recent notes.
“If QE is sizable enough, the transformation in debt-to-GDP ratios can be meaningful”, he said last month, commenting on the Draghi’s open-ended commitment to asset purchases. You can see the dynamic clearly in the following two charts:
“QE helps ‘de-risk’ financial markets, by moving bonds from risk-averse investors towards more risk-tolerant central banks (buy and hold)”, Martin said last Thursday. “This means that over the longer term, higher sovereign debt levels can be attainable, while keeping bond market ‘tantrum’ risks in check”.
Relatedly, there was unanimity at the otherwise fractious September ECB around one thing: The need for fiscal policy to take the reins – and quick.
“All members agreed that, in view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space should act in an effective and timely manner”, the minutes read, adding the following, which effectively serves as a kind of disclaimer on the new easing package:
In response to the significant risks related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, policies other than monetary policy would be more effective and were better suited to address country-specific shocks. In this context, the Governing Council should communicate carefully so as not to create unrealistic expectations about the contingencies that monetary policy was able to address.
Yes, we wouldn’t want to “create unrealistic expectations” for what can be accomplished with monetary policy.