Tuesday 24 April 2018

Politics will come into play when it's finally game over for ECB's Super Mario

Mario Draghi’s legacy is secure after his innovative approach boosted financial conditions. Photo: Ralph Orlowski/Reuters
Mario Draghi’s legacy is secure after his innovative approach boosted financial conditions. Photo: Ralph Orlowski/Reuters

Pearse Conaty

ECB President Mario Draghi earned his 'Super Mario' moniker for his role in managing the sovereign debt crisis. Draghi deftly built consensus between German and peripheral interests, facilitating the strong economic recovery we now see.

His departure in October 2019 will leave a vacuum - and speculation around succession has already intensified, with direct questions posed to Draghi at March's ECB press conference.

Draghi's successor will face a series of challenges. Draghi's legacy will be his "Whatever it takes" speech that marked an effective firebreak and inflection point in terms of the crisis in 2012.

The question now is to determine how we find 'whoever it takes' to fill his seat. This decision will have major implications for eurozone monetary policy with impacts on financial markets, corporate borrowing rates and mortgage pricing.

Senior European Jobs

The ECB Presidency is not the only upcoming high-profile position to be decided - and there will be political interplay between all the appointments.

A new European Commission President, replacing Jean-Claude Juncker, will be elected in 2019. Both Michel Barnier and Pierre Moscovici are being linked to this position.

It is difficult to see how one country could hold the Commission and ECB Presidencies simultaneously, so France is likely to prioritise the EC over the ECB Presidency, given Macron's push for fiscal integration.

The 'Big Four' of Germany, France, Italy and Spain typically have representation in senior posts. France may have the Commission Presidency, while Spain has recently secured the ECB vice-presidency for De Guindos.

Germany would look to have a good political case for the ECB Presidency.

Indeed, they have an outstanding candidate in Bundesbank President Jens Weidmann. So why may this not come to pass?

Potential Successors

Weidmann is well regarded by his Central Banking peers, having headed the Bundesbank for eight years, served as an adviser to Merkel and also has IMF experience under his belt.

A Weidmann Presidency would be viewed as meaning the end of Quantitative Easing (QE), quicker rate hikes and less tolerance for higher inflation.

Peripheral countries could expect less support from the ECB in future crises which may be destabilising.

However, there are a few hurdles to Weidmann getting the post - Germans currently head the ESM, Single Resolution Board and the EIB.

Germany is a reluctant hegemon so will be sensitive to holding too many key roles.

If Weidmann becomes President, fellow German Sabine Lautenschlager would need to step down from the Executive Board of the ECB, hurting the already fragile gender balance at top levels in the ECB.

Fears abound that Weidmann may be too doctrinaire in his approach, indeed he has been the most vocal critic of the ECB's Quantitative Easing (QE) policies.

The Bundesbank is typically a proponent of tighter monetary policy and is wary of blurring the lines between monetary and fiscal policies.

To Weidmann's credit, he has publicly tracked to the centre in the past 12 months. Whether his tone and outlook has softened enough to gain broad political backing from other countries remains to be seen. If Germany can't have Weidmann they will accept a 'Northern European' mind-set.

Germany may calculate that the political price of a Weidmann presidency is too high. If Germany instead nominates Weidmann for ECB chief economist, it would signify they cannot garner support for a Weidmann presidency.

Ireland's Philip Lane is seen as a frontrunner for the chief economist role. Alternative candidates who can align Germany's desire for tighter policies while making policy normalisation more palatable to the peripheral nations will be sought.

Finnish Governor Erkki Liikanen, Olli Rehn and Philip Lane are being spoken about as fitting these criteria.

Why it matters

The President exerts a major influence on the overall stance of the ECB. Markets tend to extrapolate future monetary policy from who they expect to lead the Central Bank.

We have seen swift rises in rate expectations when Larry Summers was being considered as Fed Chair in 2013 and last year when John Taylor was mooted to replace Janet Yellen.

The ECB is already looking to exit emergency monetary policy and increase interest rates over the next 12-18 months. A Weidmann presidency could see that repricing of rate expectations accelerate.

Managing QE unwind without triggering a sharp tightening of financial conditions choking the recovery, while building up policy space to manage the next downturn is an unprecedented task.

Add in Brexit, trade wars and a more integrationist political agenda and we can see an unenviable job for the next ECB President.

Implications for your business

Draghi's legacy is secure. Under his leadership, the ECB implemented many innovative measures that successfully harmonised an easing of financial conditions across Europe.

The result is a declining debt/GDP ratio, falling unemployment and strong economic growth.

The uncertainty his departure triggers may create volatility. Despite his more measured approach of late, the experience in the US suggests that increasing speculation around Weidmann will see rates move higher.

A new ECB President could potentially see a broader debate on the mandate, moving away from the narrow inflation focus to a broader financial stability mandate.

This could manifest as an increased willingness to lean into asset bubbles/easy financial conditions with pre-emptive rate hikes as opposed to macro prudential measures, as we have seen from the Bank of Canada.

A stronger euro, higher volatility and higher real rates will present challenges that Irish businesses can now start to prepare for.

Pearse Conaty is head of fixed income, Bank of Ireland Global Markets

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