At the meeting of the Shadow ECB Council on 29 September 2011, a four-fifths majority recommended an immediate rate cut of at least 0.25 percentage points to the ECB. Furthermore, according to the majority view, the ECB should undertake further measures to support bank funding, in particular by resuming Long Term Refinancing Operations of at least twelve months’ maturity and re-activating the Covered Bond Purchase Programme, while maintaining – or even intensifying - purchases of government bonds. In the judgement of the Shadow ECB Council, immediate action on several fronts is required because the risk of a recession is high and because the banking sector as well as several important financial markets are not functioning properly.
Growth forecasts in free fall
Members continued to revise down strongly their forecast for euro area real GDP for 2012, to 0.7% on average, which compares to the ECB staff’s September projection of 1.3% and the Shadow ECB Council’s own projection of 1.6% back in July. Meanwhile, in the view of the Shadow Council, euro area HICP inflation is expected to decline to 1.7% in 2012, down from 2.6% this year.
While few members predict an outright recession as their central scenario, the majority considers the risk of a relapse into recession to be very high.
Shadow Council macroeconomic forecasts
(Forecast means in %, previous forecasts in brackets)
|2011||2.6 (2.6)||1.6 (1.7)|
|2012||1.7 (1.8)||0.7 (1.1)|
Contributors: M. Annunziata, E. Bartsch; J. Cailloux; J. Callow; E. Chaney, M. Diron, J. Henry, G. Horn; J. Krämer, J.-M. Six
Assumptions: Most forecaster assumed that the ECB will cut its key policy rate to 1.25% within three months and to 1% within six months. .
Recession risks and dire state of financial sector warrant a rate cut
Five members regarded the recession risk to be so acute and the state of the financial system so fragile that an immediate 0.5 percentage point cut to 1.00% of the ECB’s main policy rate (currently 1.50%) was warranted. Seven members considered a cut of 0.25 percentage points sufficient as the starting point, while three members advocated unchanged rates (though two of the latter expressed a bias toward lower rates).
Those not in favour of an immediate rate cut judged that interest rates were very rather low already and that the ECB’s focus should be on measures to improve the functioning of financial markets.
Inflation risks were not considered an impediment to rate cuts by most council members, as they projected that the inflation rate would start declining soon and move safely below 2% in 2012 and 2013.
Buy covered bonds and continue to buy government bonds
There was strong and widespread support on the Shadow Council for the ECB’s purchases of government bonds, as most members considered the sharp increase in yields of Spanish and Italian government bonds as unjustified and dangerous. Most members urged the ECB to keep up these SMP purchases as needed to prevent yields from rising further to an unsustainable level. However, several members raised a moral hazard concern: that unconditional large-scale bond purchases by the ECB could undermine the incentive for the respective governments to rein in their deficits quickly and decisively.
There was a very strong consensus that the ECB should re-activate the Covered Bond Purchase Programme. Most members judged that this important funding market for banks had become dysfunctional, with the pace of issuance in September well below normal. Some members (but not a majority) even argued that the ECB should buy unsecured bank bonds.
Provide ample and longer term liquidity
There was unanimity in the judgement that an increasingly fragile situation of the banking system required the ECB to continue providing very generous liquidity to banks. Most members advised the ECB Governing Council to revert to offering a long term refinancing option with a maturity of at least one year to help banks with their liquidity planning. Some members, while supporting the goal, said that a strong commitment toward providing unlimited liquidity at a fixed rate for as long as needed would achieve the same purpose.
Founding member Thomas Mayer has left the Shadow ECB Council after a little less than nine years. Eric, Chaney, Chief Economist of Axa in Paris, has joined the Shadow Council in his place.
Members’ individual votes:
|José Alzola||The Observatory Group||cut 0.25%|
|Marco Annunziata||General Electric||unchanged||down|
|Elga Bartsch||Morgan Stanley||cut 0.25%|
|Andrew Bosomworth||Pimco||cut 0.25%|
|Jacques Cailloux||RBS||cut 0.5%|
|Julian Callow||Barclays Capital||cut 0.5%|
|Eric Chaney||Axa||cut 0.5%|
|Marie Diron||Oxford Economics||cut 0.25%|
|Janet Henry||HSBC||cut 0.25%|
|Gustav Horn||IMK, Düsseldorf||cut 0.5%|
|Erik Nielsen||Unicredit||cut 0.25%|
|Jean-Michel Six||Standard & Poor's||cut 0.25%|
|Angel Ubide||Tudor||cut 0.5%|
Frankfurt, 30 September 2011
Norbert Häring, Non-voting Chair of the Shadow ECB Council
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