Policy is Unchanged, but Draghi is Transforming the ECB

Given the new initiatives announced last month, of course the ECB stood pat.  However, Draghi announced the most far-reaching changes of how the central bank will conduct policy starting next year.  

Three important changes will take place.  In his prepared remarks Draghi focused on two, but let's put the other one on the table. With Lithuania set to join EMU on January 1, the treaties call for a rotation among the national central bank presidents for voting purposes.  The central banks from the largest countries, including Germany will vote a little more often than the central banks from the smaller countries.  

This is a bit like the rotation of the regional presidents as voting members of the Federal Reserve's Open Market Committee, with two exceptions.  First, in the US, the NY Fed has a permanent vote on the FOMC.  Some in Germany want the same thing for the Bundesbank, but it does not look particularly likely now.  Second, the Board of Governors at the Federal Reserve, when fully staffed, outnumber the regional presidents.  This will not be the case at the ECB, where the Executive Board is only five strong.    

The other two changes include a shift from monthly meetings to every six weeks, which is essentially the same as the Federal Reserve.  Draghi was clear that there was not attempt to align the meetings of the two central banks.  The reserve maintenance period has also been changed from a monthly term to a six week period.  This will produce operational changes at the member banks.  

The ECB is also working a releasing some record of its meetings.  It is still not clear what form they will take or how timely they will be.  The publication of the "minutes" will begin next year and we expected additional details to be forthcoming.  

Most of Draghi's other comments were well within expectations.  There was more technical information of about the Targeted LTROS (TLTROs) and there was another innovation:  that the TLTROs could be drawn individually or as part of a (TLTRO) group.  The dates of the TLTROs were set for September 18 and December 11.  

While many in observers have focused on the roughly 400 bln euros that could be borrowed from the facility in September and December, Draghi reminds investors that the funds available after the quarterly allotments could bring the total toward 1 bln euros. 

Last month Draghi was understood to say that interest rate policy had been exhausted, but today he seemed to backtrack a bit.  He said that a technical adjustment could not be ruled out.  It is not clear what this means, but it could be a cut in the corridor by bringing the marginal lending rate down.   

On the exchange rate, Draghi shed little fresh light.  It is not a policy target, but it is an important input into inflation.  Draghi did seem a bit frustrated with the euro's resilience despite the rate cuts and other measures. He said he was watching the exchange rate with "great attention."  

With the momentum from the stronger than expected US jobs data and the smaller trade deficit, the euro briefly slipped through $1.3600, but rebounded a bit.  Resistance is now seen in the $1.3640-60 area.  Italian, Spanish and Portuguese benchmark 10-year bond yields have eased around 5 bp, which is essentially what the US 10-year yields have risen.  While many observers will talk about how Spain's benchmark 10-year yield is poised to slip below the US yield, keep in mind that Spain's inflation is 0.2% year-over-year.  That makes its nominal yield virtually the same as its real yield.  US inflation is near 2.1%, making its real yield closer to 0.55%, about a fifth of the real yield in Spain.  

Lastly, we note that Draghi appeared to be singing from the same song book as Yellen regarding the use of monetary policy to address financial stability.  Like the Fed Chair yesterday, Draghi indicated that macro-prudential measures and regulation is the first line of defense, not monetary policy (price and quantity of money).   Monetary policy seems to blunt of an instrument and operates with unpredictable lags.  Macro-prudential policy and regulatory efforts are more precise and can be implemented almost immediately.  This is part of the new orthodoxy.