E&S: European Outlook – Can the ECB and the BoE Wrestle Back Control of Monetary Policy?

Economics and Strategy

European Outlook – Can the ECB and the BoE Wrestle Back Control of Monetary Policy?

In a performance that summed-up his term at the ECB, Mario Draghi delivered something for everyone at the June press conference. The ECB’s overall stance remains cautious, reflecting uncertainties over the state of the domestic economy, uncomfortably low inflation and global trade tensions. In response, Draghi reiterated that the ECB has plenty left in its arsenal to support the economy if it becomes necessary, including restarting QE and cutting rates. At the same time, the ECB’s task of setting policy to reflect the needs of the euro area is being made harder by the U.S. Fed’s dithering over its direction of travel and the markets projecting expectations of imminent rate cuts in the U.S. onto the European yield curve (a frustration shared by the Bank of England).

As the clock ticks down on his time as the ECB President, however, attention is increasingly turning to life after Draghi. The European Elections didn’t produce the political earthquake some had feared. Nonetheless, the two main political parties did significantly worse than in 2014, and the next step in the process is to choose who will replace Jean-Claude Juncker as President of the European Commission. The frontrunner for the job under the process of Spitzenkandidat is the German politician Manfred Weber. But if he is asked to step aside in the coming weeks in favor of another candidate (as suggested by Emmanuel Macron), then Angela Merkel could focus on the top ECB job and the nomination of Jens Weidmann.

At the moment there is widespread skepticism that the ECB would ever be in a position to hike rates or to start unwinding QE. That said, away from the hysteria surrounding inflation expectations and weak manufacturing PMIs, the ECB is nudging the markets to start focusing on a broader set of economic variables. Inflation dynamics should not be judged narrowly by the latest core inflation print but by a wider basket of indicators including what’s happening to unemployment and wages, profit margins and the GDP deflator, super-core inflation and the weight of the Harmonized Index of Consumer Prices (HICP) items in deflation.

In the UK, will the new Prime Minister be able to renegotiate a deal with the EU and steer his/her version of Brexit through Parliament before October 31? With this outcome extremely unlikely, another extension is almost inevitable, although the decision could come very late in the day with the Parliament potentially on the brink of a no-confidence vote in the government. As this mess unfolds, the calls for another referendum and a new General Election will grow even louder, although neither would be expected to produce a decisive outcome with the electorate as divided (and in some ways arguably more) now as in 2016 or 2017. Against this backdrop, the BoE will be on standby to adjust policy in either direction; but if an orderly Brexit can somehow be delivered or, more likely, Brexit is delayed into next year, the Monetary Policy Committee has a bias to tighten policy and, as in summer 2017, could surprise the markets with its resolve. FULL REPORT

— David Owen, Chief European Financial Economist
— Marchel Alexandrovich, European Financial Economist