Why I think the ECB is not about to cut the MRO rate

On Thursday May 2nd, the Governing Council of the ECB will hold is monthly meeting to determine the path of monetary policy. The market consensus seems to be that the ECB will cut the refi rate (MRO rate). I disagree. In my opinion, the ECB has repeatedly stated that it believes the channel of monetary policy transmission is still broken and that unless it is fixed monetary policy is not able to lift the Euro-Zone economy. The data also seems to imply that banks’ reliance on ECB liquidity has decreased considerably, so that the direct effect of an EONIA cut is very limited. I also believe that the ECB is aware of the limited indirect impact that an MRO cut would have on EONIA, the interbank market and the willingness of banks to lend. Last but not least, nothing of what I am hearing from the ECB is making me think that they believe a cut is the way to go. Here’s the fine detail:

Elections in Europe 2013: Calendar and Voter Intention Surveys – France, Greece, Italy, Austria and Germany

In the following lines I provide a brief calendar of the relevant elections ahead. Following this, I summarise the likely outcome of these elections in light of the present and past voter intention surveys. Much will change in the next year, but as usual much will also stay the same. I expect these political facts to ally themselves with economic and social ones and conspire to plunge Europe once again into turmoil. Until then, enjoy the calm before the storm, it seems Europe is looking at some shaky months ahead of itself.

What Happened in 2012?

This post takes a long overdue look at the monetary, financial, economic and political developments that took place during 2012 and the trends at the end of the year. It’s an exercise in taking stock and follows a relatively simple format orientated by the rudimentary, but not irrelevant, IS-LM/AD-AS approach before concluding with some remarks about the evolution of European party political systems.

During 2012 the monetary base continued to increase, thanks to accommodating central banks’ expansion of their balance sheet in the Euro-Zone and the UK. Meanwhile intervention in the USA and Japan continued, but was balance sheet neutral. Monetary policy has kept interest rates at historically low levels and financed government debt, which has led to historically low bond yields. These in turn have created what is likely to be a bond market bubble, which can be seen in some historically low pricing of corporate bonds.

Meanwhile, the expansion of the monetary base is not paralleled in the broader monetary supply. This is appears to be motivated by low growth expectations, caused by a difficult economic environment, in the EMU and in the UK. However, the situation is better inthe USA and Japan, where the expansion in their respective central banks’ balance sheets appears to have covered the gap dug by the financial crisis. Certainly, the MBS targetted QE of the Fed has helped the USA economy, as has the lack of austerity and the status of the $US as the world’s reserve currency. In the Euro-zone, the same is not true so that much of the uncertainty about the future growth of the currency area appear to be tied to expectations about its institutional fate.

The consequence is a stagnant real economy, particularly so in the UK and in Europe, while deflation in Japan continues although with hopes of reflation. Finally, the chaos of elections, austerity and uncertainty that has been plaguing the Euro-Zone is clearly disrupting the old party-political systems and causing previously marginal parties to gain an increasing share of voters’ intentions. The frustration of voters tied in their rusting golden straight jacket is most vivid in Greece where PASOK has been obliterated and where Syriza appears the new voice of the left, while Golden Dawn glooms darkly over a desperate and impoverished society, where grasping at straws and holding to their pride people begin to turn on each-other.

Unfortunately, this post fails to consider China, Brazil and the rest of Latin America, Southeast Asia, Africa and the Middle East, which given recent recent developments appear to be the most interesting. In time, hopefully, I will have the opportunity to look at them too.

The UK Referendum on EU Membership: Narrative, Economic Realities and Political Ambitions

As the the British Prime Minister is on the verge of announcing a referendum on continued UK membership of the EU, this post considers the narrative surrounding this issue and concludes that despite the arguments in favour or against, voter intention polls suggest this entire debate is a waste of time, in light of the likely incoming anti-referendum labour (led) government in 2014.

No Early Elections in Germany… But Almost?

In the Summer of 2011 I stuck my neck out and “predicted” early elections in Germany, ahead of the scheduled September 2013 deadline. I was wrong. However, and probably as a consolation gift to myself, I review some a sequence of events in the summer of 2012 that briefly appeared to set the coalition at odds with its leadership. Eventually events conspired otherwise, but who knows, may be it was closer than it seemed.

Either way, this failed prediction teached me something. Unless they have a good shot at increasing their share of the votes, junior coalition members will not break a government sooner than scheduled. That sounds obvious… Right?

Some Comments on the USA’s ISA

In a recent post discussing the Euro-Zone’s TARGET2, I made some reference to the equivalent clearing and settlement system in the USA without any depth because it was beyond the purview of that post. To address that gap, I dedicate the next few lines to this point. It’s not immediately relevant for this website, but it offers an interesting comparison with TARGET2.

What is ISA?

In the USA, the equivalent to TARGET2 is the Interdistrict Settlement Account (ISA) procedures of the Federal Reserve System. This blog post by Koning offers what is likely to be the most complete review of the system and its history. As to its function, it basically does the same thing as TARGET2.  As Dwyer 2012 puts it,

In the United States, (…) a person may get cash in Georgia and spend it in Washington State. Similarly, someone may transfer funds from a bank account in Georgia to an account in Washington State. The monetary union in the United States relies on the free movement of currency and transfer of funds across state borders to keep the value of a dollar bill and a dollar deposit in Georgia the same as its value in Washington State. The system functions this way because the United States has had a monetary union since the late 18th century.

What do ISA Balances Look Like?

Speaking of the USA, it is practical to draw on the ISA experience in order to get some perspective on Eurosystem imbalances. In March 2012, Bijlsma and Lukkezen at Bruegel offered us a little snipped of US ISA imbalances. Here’s the updated view with many thanks to the St Louis FRED.

According to the authors, “every year in April the average ISA balance over the past 12 months (April 1^st – March 31^st) is calculated and netted”. This is done by shifting holdings in the System of Open Market Account (SOMA) .  According to a blog post where Koning takes an in-depth look at the history of the ISA, the Fed might have decided not to settle the accounts between 2008 and 2012 in order to prevent (liquidity) problems in Richmond or San Francisco. According to Michiel Bijlsma and Jasper Lukkezen

“Richmond Fed total assets are currently $210bn, while its ISA liabilities are $134bn. In relative size this is comparable to the Target 2 liabilities of some Euro area members.”

Legal Feasibility of Lasting ISA Imbalances

This having become a topic of which European analysts are fond, it is not surprising to find Euro-Intelligence as the source of some clarification for what may have created the duration of these imbalances. Returning to Michiel Bijlsma and Jasper Lukkezen‘s insights, technically/legally, this was possible because

“The Federal Reserve Board is required by law to maintain par between dollars issued by the reserve banks, but not to net out ISA balances. If a Federal Reserve Bank ran out of collateral, it would be unable to settle with the other district banks.  As a result, banks in that district would be unable to transact with banks in other districts, which breaks the par between dollars issued.” (emphasis added)

The imbalances seem to be due to the problems encountered by the biggest financial entities registered in these districts, Bank of America and Wells Fargo.

“the Richmond and SF accounts are dominated by Bank of America and Wells Fargo. Bank of America is the largest commercial US bank. Its assets are $2,200bn, which is about the size of total assets of banks registered in Richmond Fed. Wells Fargo is the fourth largest bank in the US with total assets $1,258bn. Total assets of banks registered at the San Francisco Fed are USD2tn.”

The European Banking Union Negotiations – Supervision

The banking union is a particularly important item in the long term reform agenda of the EU/Euro-Zone, and one that has often been neglected. In a crisis that is characterised by the linkages between public finances and the banking sectors, as intermediated by financial markets, the banking union in all its components offers a sterelisation mechanism which stops a shock to the balance sheet of financial institutions from migrating to the balance sheet of the sovereign that they are domiciled in. This is a point which is clear to the ECB’s Draghi who said as much at the latest post ECB Governing Council Meeting press conference:

“The main aim is to break the link between the sovereigns and the banks. It is to make the banks basically reliable, trustworthy, regardless of the place where they have their headquarters and where they exercise their business“

Adding this to the protection from public finance shocks that the OMT has offered banks, would be a leap on the way to a permanent solution to this Euro-zone crisis.

Given the protracted duration of the banking union negotiations, and its aforementioned relevance, I believe that it is only appropriate to review the relevant issues and positions as they stand at the end of 2012. In a sense this post is a continuation and a consolidation of the post I wrote back in September.