The weather is beautiful outside and the sun is also shining in Frankfurt. Also in the room where the annual meeting for the economists and analysts who follow the European Central Bank (ECB) took place, the ECB executives present played nicely.
In this context, 'soft patch' stands for a shorter period of less favorable economic weather. "Experiencing such a period does not mean that a recession will inevitably follow," Mario Draghi, the president of the ECB, told his audience. To reinforce this fact, the ECB leader turned to history. "Since 1970, the eurozone has experienced such a soft patch 50 times, and only 4 times followed a recession. Take 2016 as an example. Even then, growth in the euro area declined, but economic activity picked up again quite quickly."
Domestic economy
“What saved the eurozone economy from recession at the time was a strong domestic economy,” Draghi said. The key question, according to him, is whether the domestic economy can repeat that trick in 2019. Whether this is possible, in turn, depends on 2 pillars of the domestic economy: business investment and household consumption.
However, the ECB sees sufficient reasons to believe that the investment pillar will not collapse. When it comes to consumption, the state of the labor market is decisive. When unemployment is low (and falling), wage increases increase. So far, that pillar has made its contribution. Outperform throughout the Eurozone the wage increases namely inflation.
All in all, the ECB is not having sleepless nights. On the other hand, negative risks for growth are fully present. It could therefore be that growth will slow down further.
What should happen next?
When we look at the monetary policy to be pursued, the ECB is in a difficult position. The bank does not know how things will proceed, and you can then expect that the prudent policy is to do nothing. As a central bank you look at the situation and wait until the fog has cleared, after which you can look ahead more clearly.
However, that is not how the ECB works. "We do not have the option to do nothing, because we always have to do something," said Yves Mersch, President Draghi's colleague. Knowing that the ECB will not look at the situation, the 'one million euro question' is: what will the bank do?
After listening to the presentations and various discussions, there can hardly be any confusion: the ECB will further expand its policy. The chairman of the ECB It was not without reason that he concluded his presentation with: "We are not short of instruments."
Move interest rate increase
The first thing the ECB can do (and in my opinion will do later this year) is to postpone the moment of the next interest rate increase even further; earlier this year, that moment was already shifted from autumn 2019 to sometime in 2020. If the macroeconomic data show that the soft patch will last longer and be less soft, then I will not be surprised if the ECB implements the first interest rate increase sometime in 2021 .
Another option is for the bank to make monetary policy looser through more favorable conditions for banks to take out TLTRO loans from September. Peter Praet, the ECB's chief economist, said the likelihood of a deeper and longer soft patch increases as banks tighten lending. "If you see that happening, then you are too late to intervene," the Belgian said.
In other words: the ECB only takes action when the bank suspects that banks are granting fewer loans. As a supervisor, the ECB has almost 'real time' data on this information, which means that the bank can indeed take action on time. A third option is for the ECB to once again purchase corporate and government bonds.
Dark clouds
My conclusion is that the ECB is currently seeing dark clouds, although it expects them to clear up soon. To be on the safe side, the interest rate will remain at 0% for a long time. If that prediction does not come true, the bank will not hesitate to use other instruments to part the cloud cover.
In addition, long-term interest rates will remain low for the time being, at least until there is more clarity about the soft patch. If the soft patch blows over fairly quickly, rising long-term interest rates can be expected. However, if a period of lower growth continues for a longer period, interest rates may remain low for some time to come. Ultimately, these will rise, especially to stimulate the economy if the low growth phase lasts longer.