Anxiety is spreading across the Eurozone as the European Central Bank (ECB) is planning to gradually remove its stimulus late in the business cycle, stirring concern of an economic slowdown or recession amid the highly-leveraged business environment.
Kristian Rouz — European Central Bank (ECB) policymakers are weighing the possibility of rolling out the first interest rate hike in over a decade as soon as in 2019 due to accelerating growth and firming inflation in the Eurozone.
Such a bold policy move, after years of slow recovery and despite a quantitative easing (QE) program worth trillions of euros, is fueling anxiety among investors and private-sector business owners.
To make the sentiment worse, 2019 is the year ECB President Mario Draghi is expected to leave his post.
“There is very little visibility for investors from the second half of next year onward,” Marchel Alexandrovich of London-based global investment bank Jefferies says. “It’s not just that there are very few templates for what happens next, but also that there will be new actors on the stage.”
This calls into question the stability and predictability of the ECB policy course to a much greater extent than, for example, in the US, where the succession from Janet Yellen to Jerome Powell as Chair of the Federal Reserve dealt a stunning blow to the markets last month.
Over the past decade, the ECB has pursued a two-pronged monetary accommodation policy course. Firstly, the monthly purchases of bonds by the central bank allow for the injection of additional liquidity into the Eurozone’s banking system in order to bolster commercial bank capitalization and lending activity.
Secondly, the policy of zero-to-negative interest rates, known as ZIRP and NIRP, has brought down the costs of credit products in the Eurozone, making consumer and business financing more affordable.
A combination of the two has spurred both lending and borrowing, fueling overall economic activity and growth in the Eurozone and yielding positive indirect effects on the GDP expansion of its closest trade partners.
However, Draghi’s departure and the looming changes in ECB policies might put such a growth model in jeopardy.
“The ‘well past forward guidance’ (the ECB’s intent to keep interest rates low after wrapping up the QE) in terms of rates could be dropped more quickly than the markets are currently priced for,” Derek Halpenny of Japanese bank MUFG said. “If we get an end to QE in September, which I think is now quite likely, that first rate hike could come a lot sooner than maybe the markets are thinking.”
The ECB has already agreed to end its bond-buying program later this year — mainly due to the lack of fixed-income assets available for purchase in the open market.
Meanwhile, a 2019 increase in base interest rates would come late in the current economic cycle (which commenced roughly in 2012-13 after the most acute phase of the European debt crisis ended), and would also coincide with possible disruptions in international trade, caused by Brexit and US President Donald Trump’s new trade policies.
The ECB has three benchmark interest rates — unlike the US Fed, which sets a loose gauge of base borrowing costs. The ECB’s rates are the main refinancing operations rate (MRO), deposit facility rate, and the marginal lending facility rate. They currently stand at 0, —0.4, and 0.25 percent, respectively.
Meanwhile, market expectations are that the ECB will raise its deposit rate from —0.4 to zero by June 2019 with a 20-percent probability, and by the end of that year — with a 40-percent likelihood.
“I don’t think the ECB has already made up its mind” when to move rates, Daniel Lenz of DZ Bank AG in Frankfurt said. “Also open is the question of whether the (Governing) Council will at first only hike the deposit rate or whether we’ll see a combined move — a hike of both the deposit and main refinancing rate.”
At this point, the ECB’s main concern is crafting a market-appealing statement to explain the end of QE, expected this coming September. Policymakers are set to evaluate the market reaction to that move, as well as its impact to the economic growth and business and consumer activity, before weighing their approach to interest rates.