Wednesday 23 October 2019

Ronan Costello: 'ECB needs to replace 'whatever it takes' stance with 'over to you' approach'

Collaboration could be key for Christine Lagarde as she takes on the role of ECB boss. Photo: AFP/Getty
Collaboration could be key for Christine Lagarde as she takes on the role of ECB boss. Photo: AFP/Getty

Ronan Costello

One of the principle tenets of the New Zealand rugby team is to "leave the jersey in a better place". The message to newly capped players is clear: you have been given an honour, respect the jersey, improve yourself as a person and a player, and you represent all previous and future wearers of this jersey.

Does it work? Well, they won the last two world cups and are favourites to make it three in a row.

The day before the 2019 World Cup final, outgoing European Central Bank (ECB) president Mario Draghi will pass his jersey on to former head of the International Monetary Fund (IMF), Christine Lagarde. Has Draghi left the jersey in a better place?

The short answer would have to be 'yes'. When Draghi became ECB president back in 2011, the euro area was in the midst of a sovereign debt crisis that would mutate into a very real existential threat for both the euro and the EU bloc.

Draghi showed strong leadership, took decisive action and committed to do "whatever it takes" to preserve the euro and restore confidence.

He successfully averted disaster, so it's fair to say the jersey is in a better place.

But you'd also have to say that the stitching is torn and the fabric has been significantly compromised.

Under Draghi's stewardship, the ECB has cut interest rates to negative, bought more than €2.5trn in bonds and introduced multiple lending programmes to support the real economy.

But growth has been weakening over the past year and the ECB is still a long way from its inflation target.

In recent months, several ECB members have questioned the effectiveness of taking further monetary steps.

Many have voted against Draghi's policies, expressing discontent with the magnitude of the ECB's balance sheet expansion, and the level of negative deposit rates, which have become penal to savers across the eurozone.

At last month's ECB meeting, Draghi called on fiscal authorities to "take charge" and become the main policy of economic expansion in the eurozone.

However, on that same day, the ECB cut interest rates and agreed to reopen its asset purchase programme indefinitely.

So the actions didn't back the message and Draghi remained faithful to his "whatever it takes" mantra.

This is the cycle that Lagarde now needs to break. "Whatever it takes" should be retired and replaced with a new refrain, perhaps "over to you".

And that message to fiscal authorities needs to be backed by action - or, in this case, a lack of action, by the ECB. Sometimes, when your team is under pressure, the best thing you can do is hoof the ball down the pitch and take a breather.

It would be a bold move for Lagarde to depart from Draghi's methodology early in her term, but the timing looks ideal.

In a recent report, the European Fiscal Board advised those countries with fiscal capacity to use it and to take advantage of extremely low funding costs - and this is a key point.

The policies enacted by Draghi's ECB have significantly reduced sovereign funding rates, so it's an opportune time for fiscal authorities to return the quid pro quo.

Recently, the French and Dutch finance ministers announced packages worth €10bn and €3bn respectively, but what about Germany? Angela Merkel, who has a very good relationship with Lagarde, recently noted the importance of not over-burdening monetary policy.

But German leaders are split between committing to their 'black zero' policy of balanced budgets and opening up the coffers to stave off a recession.

The result may be a 'shadow budget', with debt being raised through non-federal agencies to improve infrastructure and help Germany meet its 2030 carbon reduction targets.

If this is large enough, it could boost the German economy and take some pressure off the ECB.

It also chimes in well with Lagarde's pledge to support the green agenda.

Another option open to Lagarde is to move the goalposts, and there may be an opportunity to do this in an upcoming review of the policy framework.

Up until now, the ECB has remained loyal to a 2003 agreement to target an inflation rate of below, but close to, 2pc over the medium term.

This definition of price stability looks rigid and dated, and Lagarde may be able to garner support for a more flexible mandate, which would loosen the shackles that impeded Draghi over his eight-year term.

Innovation was the hallmark of Draghi's ECB presidency. For Lagarde, it will be collaboration. The challenges facing her are formidable, but as a pragmatist, a proven influencer and the ECB's most international president, she is tailor-made for the job.

In her previous roles as French finance minister and IMF chief, she has also built a network of relationships that will support her ECB presidency.

Over the next eight years, I expect her to build a greener, more collaborative and more flexible central bank and, ultimately, to leave the jersey in a better place.

Ronan Costello is head of euro money markets, Bank of Ireland Markets & Treasury

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