ECB and Fed in Unison: Loose(r) Policy Here to Stay

April 24 2019

“In a dark room, you move with tiny steps. You don’t run, but you do move,” as Mario Draghi, President of the European Central Bank (ECB), describes the precarious monetary conditions in the Eurozone. A mistake, in my view, because if you’re unable to see, you inevitably get lost. Thus, if you grope in the dark, it would be wise to keep still and wait until some light enters the room or until your eyes become used to the dark.

By now, the ECB appears to have seen the light (pun intended). The central bank remains idle in that dark room but is no longer aimlessly wandering around. The board is keeping still and waiting until a ray of light enters the room – at least, that is how I interpret Draghi’s comments about the need for additional information to determine the future course of the ECB’s monetary policy.

This vesting period will last until June 6, the day the board will meet again. The central bank will wait until June because the economic navigation system is malfunctioning. Every other minute, its screen indicates that the route has to be recalculated. It is clear that economic growth is weakening, weakening by such a margin that a period of substantially lower growth appears to be longer-lasting than the ECB expected earlier.

The weakness of several emerging economies is a risk, just like the tensions between Washington and Brussels now the US and EU are threatening with imposing new import tariffs on many of each’s products.

Even if it were true that these risks have been exaggerated, it would still be necessary to apply a generous dose of monetary antibiotics to fight off the infection of low growth and weakening inflation in the Eurozone, according to the ECB. But the uncertainty – how long the slowdown will last, how things will develop outside the Eurozone, etcetera – is huge.

This is why an earlier planned rate hike have been taken off the table. I would categorize the intention of raising borrowing costs in 2020 as wishful thinking or chitchat rather than a serious possibility. I seriously consider the possibility of a worldwide recovery in economic growth later this year, to then cool again in 2020, to such an extent that a recession in the US and Euroland would be a real possibility by that time.

If 2020 or 2021 turns out to be a recession year, not a single central bank would want to stop a recovery in its tracks by raising rates too fast. Then it would take until spring 2023 before a newly elected ECB President will announce a decision of the board to raise rates from 0% to 0.25%.

In short, I would expect a new round of quantitative easing before any rate hike. When Draghi said that the ECB “is ready to use all instruments to spur inflation in the mid-long term”, while at the same time repeating and highlighting the word “all”, I interpreted it as the equivalent of his famous “whatever it takes”-statement.

More precisely, this would mean: if keeping rates at 0 percent turns out to be insufficient to reach its goals, the central bank will not hesitate to use its quantitative easing cannons yet again.

From the other side of the ocean we receive signals that, once deciphered, point at a similar posture. The Fed is in no rush to raise rates. And even if the Fed would be in a rush, I seriously doubt whether it would be able to do so. On the one hand because economic conditions are not, in my view, conducive for rate hikes, and on the other hand because I doubt whether the interest rate committee, especially in a scenario of weak economic growth, and with new board members who appear to be loyal to President Trump, will be willing to raise rates in the 2020 election year.

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