By Ambrose Evans-Pritchard
The palace revolution at the European Central Bank is a systemic event for global finance. The New Keynsesian ascendancy of the Draghi years has been overthrown, with large implications for the political economy of the euro project and the debt sustainability of Italy.
Scorched-earth hawks at the German Bundesbank have regained control over the policy machinery after a decade in opposition, ending the North-South truce that has held the euro together for the last decade.
The de facto leader of the ECB at this juncture is Isabel Schnabel, the German board member of the executive council, who has returned to Ordoliberal orthodoxy after a fling with easy money that provoked a torrent of criticism in Germany, and that she now regrets.
It is not the ECB’s half point rise in interest rates to 2pc that has shaken markets out of their complacency. Nor is it the launch of quantitative tightening (QT) next March at a pace of €15bn (£13bn) a month, even though this pulls away the debt shield for eurozone governments just as they are struggling to cover their energy bail-outs and need to fund an estimated €1.3 trillion of gross debt issuance next year. Both were expected.
The wicked surprise was to push the ECB’s “terminal” rate to 3.5pc (some even see 4pc) as the eurozone economy clatters into recession.
If you add up all the implied rate rises – from a nadir of minus 0.5pc – as well as the cumulative shift from QE to QT and a further €1.4 trillion fall in the ECB balance sheet by next June as banks repay their free loans (TLTROs), you approach 600 basis points of monetary tightening under the Wu Xia principle. This is colliding with public and private debt ratios bloated by serial shocks.
The ratchet effect acts with a delay: Spanish floating mortgages are repriced annually off one-year Euribor rates, for example. S&P Global says the test for European companies will come next year as they try to refinance €753bn, followed by another €708bn in 2024. The days when BBB- companies could issue junk bonds at negative rates are a distant dream.
Eventually something is going to break, most likely a liquidity squeeze and a chain-reaction of margin calls in the shadow banking nexus, akin to Britain’s misadventure in September with liability driven investments. That episode is viewed in sophisticated financial circles as the canary in the coal mine for a world with too much opaque leverage, rather than as a particular UK problem.
The impact of derivatives collateralisation on liquidity risk: evidence from the investment fund sector.
Vitor Constâncio, the ECB’s former vice-president, says the fundamentalists now in charge of his old Alma Mater have weaponised the inflation forecast, putting an extreme construction on the data in order to justify hard monetary tightening that cannot otherwise be explained.
The ECB staff predicted in September that inflation would fall back to 2.3pc by 2024. The new regime has since lifted the figure to 3.4pc, even though oil and gas prices have plummeted in the meantime and inflationary pressures are ebbing.
Note that the Bank of England is going in the opposite direction with a 1.5pc forecast for 2024.
One can get lost in the weeds of these Alice in Wonderland forecasts. The point is that the ECB is a political animal subject to political forces. Disobedient data can always be compelled to fit prevailing ideology.
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Christine Lagarde has pushed the ECB’s ‘terminal’ rate to 3.5pc as the eurozone economy clatters into recession. Credit: Daniel Roland/AFP