Tuesday 22 October 2019

Ronan Costello: 'Draghi's successor at ECB will need to plough fresh furrow as policy is now blunt tool'

End of an era: Mario Draghi’s famous ‘whatever it takes’ declaration looks dated. Photo: Bloomberg
End of an era: Mario Draghi’s famous ‘whatever it takes’ declaration looks dated. Photo: Bloomberg

Ronan Costello

Over the coming weeks, newly-elected EU leaders will appoint new presidents to four key posts, finding replacements for President of the European Parliament Antonio Tajani, the European Commission's Jean-Claude Juncker, the European Council's Donald Tusk and the European Central Bank's Mario Draghi.

The recruitment process is non-standard, closer to a papal conclave than the usual CVs and interviews. Each country and political group will be jostling for position and cutting side-deals in the pursuit of power.

Negotiations promise to be long, tribal and clandestine, but eventually the names of the successful candidates will emerge.

For financial markets, the biggest question is who will replace Mario Draghi.

In his many press conferences, Draghi often used the phrase, "we are all EU citizens", but that concept will be forgotten pretty quickly during this process, which looks like a penalty shoot-out between the easy-money doves of France and the monetary hawks of Germany.

The announcement of Juncker's successor as President of the Commission could be critical in determining who takes over the ECB. If Manfred Weber of Germany becomes the new Commission President, that would put France in the lead for the ECB slot.

On the other hand, if Michel Barnier makes a successful run for Commission President, a German will probably become ECB President.

Lining out for France we have the Governor of the Bank of France, Francois Villeroy de Galhou and current ECB board member Benoit Coeure, who have both supported the ECB's dovish policies.

Alternatively, there is the highly respected Christine Lagarde, who currently chairs the IMF. Lagarde, seen as quite a hardliner when it comes to fiscal and monetary rules, took herself out of the race last year, but that can always change, and she would be the most palatable French candidate from a German perspective.

The German team is captained by Bundesbank president Jens Weidmann, the most contentious candidate in the running.

Weidmann has been openly critical of a number of ECB policies and his election would definitely ruffle market feathers, probably sending peripheral bond spreads wider. The Bundesbank Vice President, Claudia Buch or Klaus Regling, CEO of the European Financial Stability Facility, would probably be seen as less-controversial options.

If France and Germany fail to agree a candidate, the door then opens to others who have declared an interest.

These include President of the Dutch Central Bank Klaas Knot, Governor of the Bank of Finland Olli Rehn, or his predecessor at the Bank of Finland, Erkki Liikanen. Knot is probably too much of a monetary hawk to gain popular support, but either of the two Finns could be amenable to both sides.

Ireland's Philip Lane, who has just taken over as the ECB's chief economist, will be following with interest.

There are a few non-economists in the running for president, including Villeroy de Galhou, Lagarde, Rehn and Liikanen and if one of these get the nod, that would put Lane in a very influential position as the leading economic voice on the executive board.

The next ECB president will not be the only newcomer in 2019. By the end of the year, at least 10 of the 25 ECB council members will have changed, and they arrive at an interesting time.

Not in the middle of a financial crisis, like Draghi, but facing a significant growth and inflation challenge at a time when Donald Trump's trade policies are casting a menacing shadow over the global economy. It's increasingly likely that the fresh blood will need to bring some fresh ideas.

With monetary policies nearing exhaustion and borrowing costs at historically low levels, the case for a review of fiscal rules is strong.

This falls outside the remit of the ECB, but the new ECB president may well benefit from fostering closer ties with fiscal authorities and formulating a more collaborative approach to economic stimulus.

There are also some contentious policies that were discussed in the Draghi era, but never implemented, that his successor may pursue if economic conditions deteriorate.

These would include options such as: expanding quantitative easing to include equity purchases; issuing euro bonds to finance public investment; or crediting "helicopter money" to EU citizens to give a short-term boost to growth and inflation.

To get off to a good start, Draghi's successor should conduct a comprehensive review of the ECB's operational framework.

This hasn't been done since 2003 when it was agreed to target an inflation rate of below, but close to, 2pc over the medium term. This is looking dated in my opinion, as is Draghi's 2012 commitment to do "whatever it takes" to preserve the euro.

Olli Rehn is calling for a review of ECB's policy framework in light of persistent inflation undershoots.

This might lead to a more flexible inflation mandate. After all, is low inflation a scary thing if it's driven by cost efficiencies, corporate competitiveness and improved productivity?

What the Draghi era has shown is that, used in isolation, monetary policy is a pretty blunt tool that becomes less effective the more you use it. Draghi, following his coronation in 2011, was always in a tight spot.

He didn't enjoy the support of fiscal stimulus and was left to plough a lonely furrow, and he ploughed the monetary furrow hard and for a long time. In fact he ploughed it late into the night and to the point where the plough has become close to ineffectual.

In an effort to stimulate the euro economy, Draghi's ECB has cut its deposit rate down to minus 0.40pc, implemented a number of programmes to support lending into the real economy and purchased over €2.5trn of bonds.

And yet, eurozone growth remains unimpressive and inflation at 1.2pc year on year continues to fall below its 2pc target.

Draghi proved himself as an innovator, someone willing to push boundaries. His successor will need to be a collaborator, willing to uproot and redraw some of those boundaries.

Ronan Costello is Head of Euro Money Markets, Bank of Ireland Markets & Treasury

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