All eyes will be on the European Central Bank today.
With Italy in political chaos (yes, yes, what’s new?), France and Germany both facing potentially transformational elections next year, and Brexit continuing to play out in the UK, everyone is looking to one man – Mario Draghi – to do “whatever it takes”.
After that, for his next trick, Mr Draghi will unveil the blueprints to a functional cold fusion reactor he’s been building in his living room.
Mad, isn’t it?
If ever you needed a good illustration of the ridiculous levels of responsibility that markets, politicians and economies in general have dumped on central bankers over the past couple of decades, this is probably the best one you’ll get…
Mario Draghi can’t do much about Italy
The European Central Bank (ECB) is having its regular meet-up today to discuss how it can best continue to plaster over the eurozone’s fundamental structural problems.
The announcement comes at 12:45pm, and then at 1:30pm, ECB boss Mario Draghi explains everything and massages the market’s expectations for the next month or so with various verbal cues, some masterful misdirection, and the curt dismissal of the occasional tricky question from the press pack.
Adding a little extra spice to today’s money-printing decision, of course, is the resignation of the Italian prime minister, Matteo Renzi. That leaves the Italian banking sector still sitting in limbo, despite everyone knowing what the problem is (they’re broke because they have too much bad debt) and what the solution is (decide who bears the cost of these banks’ mistakes, and then give them some money to sort themselves out).
Despite the apparent hopes of some in the market, Draghi can’t directly do anything to help the Italian banks through monetary policy. But he certainly won’t want to do anything to rattle markets any further.
So what might we see later today?
At the moment, the ECB is printing €80bn a month to buy eurozone government bonds. That started back in March 2015. The original plan was for that to stop in March 2017.
The market expectation is that terminating quantitative easing (QE) won’t happen, given the Italian election results. The only real question is how long Draghi will extend it for, and whether he’ll keep the printing at €80bn or “taper” it a bit.
The ECB is in a tricky position – nothing new about that, of course. There’s the basic problem in that the Germans aren’t fond of QE, whereas just about everyone else in the eurozone needs it. So they won’t be keen for Draghi to extend QE.
On top of that, believe it or not, the eurozone is actually showing signs of recovery. The Citi economic surprise index for the eurozone is at its highest level since 2013, as Kathleen Brooks of City Index points out. In other words, most of the economic data is beating analysts’ forecasts just now.
So that makes it all the trickier for Draghi to justify the continued pessimism that would require yet more QE.
There’s also the problem that the ECB is running out of bonds it can buy. This is a tricky issue. The ECB has a couple of fairly tight restrictions on its actions.
Firstly, it can only buy bonds with a yield of negative 0.4% or above. That shouldn’t be a problem (I mean, who’d be crazy enough to buy a negative-yielding bond, right? Ehm…) but it is, given that yields on many of the “safest” government bonds are indeed, at negative levels.
(Of course, that’s partly because bond investors know that central banks are piling into the market, but put that aside for now).
Secondly, and probably more significantly, the ECB has to buy these bonds in proportion to the size of each country’s economy and population. So it has to buy more German bonds than Italian bonds, even although there are a lot more Italian bonds out there to buy (and the reality is that Italy could really benefit much more from the low interest rates than Germany will).
So Germany gets stimulus that it doesn’t need or want, while Italy doesn’t get enough.
So you might find the ECB cuts down on the monthly quantity it buys, but extends the programme for longer than the market expects – buying €60bn a month up until December 2017, say, rather than €80bn up until September. And it might also make noises about being allowed to make its bond-buying criteria more flexible.
Draghi might be more aggressive than anyone expects
If you’re losing the will to live (or at least read on) by now, I’m not surprised. It’s all fiddling while Rome smoulders.
It wouldn’t surprise me if Draghi is more aggressive than the market expects. He’ll extend QE, but perhaps he’ll buy fewer bonds and won’t extend by as much as investors hope.
At the end of the day, in its current form, it doesn’t help matters and in fact, negative rates hurt banks – which is the last thing he wants to do.
That would push the euro a bit higher (and take some pressure off the dollar too – as my colleague Dominic Frisby hinted at yesterday).
Meanwhile, it would also make clear that Draghi doesn’t have a magic wand. He can’t solve the Italian banking crisis, regardless of how much money he prints. It’s a political problem and it needs to be dealt with by politicians, not the central bank.
That’s pretty much the story of 2016 of course – the handover from central bankers to politicians. The implications of all this are playing out in Europe last of all, where electorates are finally insisting that their leaders stop passing the buck on the trickiest issues around what being part of a single currency implies about politics and sovereignty.
Next year is likely to be when we see all of this come to a head. What will be the outcome?
Well, it might surprise you, but there’s the potential for Europe and the eurozone to shock us all on the upside next year. We’ve explained why in our special forecasts issue – out tomorrow. Look out for it, and if you’re not already a subscriber, sign up now.