ECB’s talking heads need to be singing same tune

David Chance

Get lucky: ECB's Fabio Panetta name-checked Daft Punk to urge running the economy ‘hot’

March 11 2021 02:30 AM

Once upon a time, central banks would cut interest rates to boost the economy. But since the financial crisis hammered rates to zero and below, that no longer works.

It has been almost two years since the European Central Bank (ECB) cut rates to minus 0.5pc, close to seven since they dipped below zero for the first time, and a decade since it managed a hike.

Today’s ECB meeting won’t see a rate change; what will matter though are the words of its chief, Christine Lagarde, as she seeks to staunch a rise in bond yields that originated in the US and could hit indebted eurozone countries and stymie their recovery.

Last week ECB board member Fabio Panetta name-checked Daft Punk’s Harder, better, faster, stronger to urge running the economy ‘hot’.

Mr Panetta might have been better off citing the French synth duo’s Get Lucky. He was one of nine ECB rate setters to speak out recently, including Ireland’s Philip Lane, in a what ended up as a cacophony of voices rather than the outline of a policy path.

“The message so far has been far from clear, with differences in emphasis between real yield moves versus nominal yield moves, the importance of bond yields versus overall financial conditions and whether current yield levels should trigger action,” according to Nick Kounis of ABN AMRO.

The ECB and the Federal Reserve in the US are having difficulties getting to grips with the speed of a rise in US government bond yields, where the 10-year maturities have seen rates rise half a percent from the start of the year to push up to 1.6pc – three times the level seen last August.

A central bank that speaks with a cacophony of voices may have no voice.

The ECB has compounded market confusion by cutting its pandemic bond purchases, although Italy can still borrow at lower rates than it could pre-pandemic.

Part of the problem is that attempts to teach markets to “think like a central bank” (in the words of influential economist and former Fed vice chair Alan Blinder) have morphed into a feedback loop where investor panics demand yet more reassurance.

Even after a decade of guidance, markets and economists still over-predict the actual Fed rate more than 70pc of the time, according to a study by Wells Fargo.

The ECB, with its 19 national central bank rate setters plus six members of the governing council, also appears to be vulnerable to Mr Blinder’s warning that a “central bank that speaks with a cacophony of voices may, in effect, have no voice at all”.

The ECB probably isn’t helped by two missteps in comments from Ms Lagarde since she took office, the first of which triggered a rise in Italian bond yields and the second stoked an unwanted rally in the value of the euro.

The bigger story from this is welcome news in the form of stronger US growth and the prospect of higher inflation. It is also a welcome shift to contemplate a world in which central bank policies and words are not the only game in town.

It is almost nine years since Mario Draghi promised to “do whatever it takes” in what was probably the most powerful piece of central bank jawboning in history.

“For decades, monetary policy has been the tool for demand management in the economy, which has certainly helped to reduce macroeconomic volatility in recent decades,” writes Innes McFee, chief global economist at Oxford Economics.

“But as we have pointed out, monetary policy has lost both its potency and room for manoeuvre,” he said.

It would be nice to think of channelling Daft Punk as the high water mark of central bank verbal intervention.

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