By Bas van Geffen, Senior Macro Strategist at Rabobank
When the ECB expanded its asset purchase programme to include sovereign bonds in 2015 policymakers went to great lengths to explain that this wasn’t monetary financing, and that this programme therefore didn’t violate the Treaty on the Functioning of the European Union, which explicitly prohibits the monetary financing of sovereign debt. Policymakers said they would not participate in the primary market, and they promised that the purchases would be temporary. Pinky swear!
Yesterday, Philip Lane addressed a conference on the topic of central bank liquidity. The ECB’s Chief Economist concluded that “a durable level of central bank reserves is likely required,” even if that level is significantly lower than the current amount of liquidity. And the supply of reserves should be able to respond quickly in the event of financial stress. Few economists will disagree.
But Lane continued, “in view of the trade-offs posed by each individual instrument, it seems proportionate from a macroeconomic perspective for a central bank to use a range of instruments to provide central bank reserves.” Main refinancing operations and the marginal lending facility –the ECB’s standard instruments– can offer the flexibility needed to respond to shocks but it arguably does not create a very solid level of reserves (although operations can easily be rolled over). Lane added that “a mix of a structural bond portfolio and longer-term refinancing operations would provide longer-time liquidity to the banking system” (emphasis ours).
Yes, you read that correctly. He essentially suggests that the ECB could permanently hold (part of) the APP and/or PEPP purchases on the balance sheet. This can only be achieved by replacing maturing assets as soon as the portfolio size falls below a certain threshold. So much for temporary? And hello again Karlsruhe? It seems like ECB officials have also prepared for legal challenges already, seeing that Lane explicitly refers to the “proportionality” of such a structural portfolio.
Lane’s remarks offered little support to European fixed income, though. Yields on 10-year sovereign bonds rose across the board by some 2-3 basis points. The rise in US yields was more pronounced, after a 30y Treasury auction attracted only weak demand. Additionally, trading in Treasuries experienced some hiccups after a ransomware attack on the Industrial and Commercial Bank of China forced clients to re-route trades, potentially hitting liquidity. The question remains to what extent this also dampened demand for the new 30y Treasury. Apparently the bank creatively used USB sticks to physically transmit settlement data. Does that technically make these Treasuries bearer bonds again?
European equities, on the other hand, performed relatively well, not in the least part driven by German chemical manufacturers. Germany’s energy-intensive industrials got an uplift from a series of electricity price support measures aimed at the manufacturing sector. Earlier this week, ECB economists warned that “there is still a higher proportion of companies expecting to move production out of the EU than into the EU,” mainly citing cost factors. With a 5-year support package the government seeks to stem the departure of its industrial giants. The measures include a sharp cut in electricity taxes from €15.37 to just €0.50/MWh, topped up with additional support for energy-intensive producers. According to Economy Minister Habeck, “very energy-intensive companies can achieve an electricity price of less than 6 cents from 2025.”
The fact that this is a multi-year effort provides some much-needed certainty to these manufacturers. The German government is setting aside up to €28 billion through 2027 to fund the plan. That’s the cost of keeping vital industries in Europe, and the cost of strategic autonomy. Crucially, Germany can still foot such a bill. In fact, according to the government, the plans can be funded without risking a breach of the country’s debt brake rule. But other countries may not have that luxury – although a decision on the new fiscal governance framework has been kicked down the road for another month: “There is a strong commitment by all member states to contribute, to work together and to reach a balanced deal before the end of the year.”
Moreover, these German subsidies do not fully eliminate the risk of rationing, should Europe again find itself in as dire a situation as last year. Some manufacturers may therefore still avoid Germany, or Europe, as their production hub – or at least will be hesitant to expand into the continent. More permanent, EU-wide solutions are needed, rather than a patchwork of temporary and local subsidies in an attempt to keep and attract key manufacturing processes close to home.
This requires a re-think in Brussels, not just on the fiscal framework that has been delayed once again. France, for example, pledged to cut spending further if growth disappoints. Depending on the areas where spending is cut, that could delay Europe’s ambitions to become more self-reliant. The future of Europe requires an integrated view on fiscal policy, industrial policy, and – perhaps – monetary policy aimed both at fighting inflation whilst also supporting some of these initiatives to create a structurally stronger Europe. We coined the possibility of “rate hikes plus acronyms” to deal with new economic setbacks. But the lines in the sand are gradually shifting as European politicians get to grips with the reality they are facing. Some governments may not mind that structural bond portfolio…
Elsewhere, US continuing claims edged higher, to the highest level since mid-April. Still, Powell warned that interest rates may have to rise further: The FOMC will be careful, but “if it becomes appropriate to tighten further, we will not hesitate to do so.” The RBA’s Statement on Monetary Policy similarly warned that the fight against inflation wasn’t over yet. The RBA raised its inflation projections across the board, and continues to flag that there could be further upside surprises. This warranted the hike in November, but policymakers are mindful of the squeeze on households’ budgets