Did ECB's Hansson Talk out of Turn?

Ardo Hansson is the Chicago-born Governor of the central bank of Estonia. He was interviewed by Market New today. He seemed to say that barring a surprise; the ECB can end the asset purchases next September.

Recall that last month the ECB indicated it would continue to extend its purchases through the first nine months of next year, albeit at half the current 60 bln euros a month pace. It specifically chose not to provide a hard end-date. This seemed to be somewhat controversial as some (the usual representatives from creditor nations suspected) wanted an official end date. Leaving aside the merits of extending or not, we think that tactically it would have been a mistake to draw a line when it was not necessary. We suspect that investors could have reacted differently and counter to the desire of officials.

Hansson was quoted saying the asset purchases will likely end in September, provided the economy evolves broadly in line the ECB forecasts, including an uptick in inflation. Hansson argued that stopping purchases entirely must be one of the options that the ECB will consider. Can there really be any doubt that Hansson or another official will propose ending the purchases? They probably would have preferred a six-month extension rather than nine.

The key issue is not whether it is an option, but will it be supported by a majority. Of course, the much depends on the evolution of prices and the regional economy more broadly. However, what many might not realize yet, as it may not be found on many calendars is that in the middle of next year, European banks can begin repaying without penalty the funds borrowed in the ECB's Targeted Long-Term Repo Operation (TLTRO).

The paying back of the funds, since the extra liquidity is costly with negative deposit rates and negative short-term rates, the ECB's balance sheet may be shrinking when it begins deciding what to do in September. This may seem like a premature tightening of financial conditions to many ECB officials. Such a reduction in the ECB's balance sheet may spur the central bank to gradually taper the 30 bln euros monthly purchases to allow a more gradual end to the purchases.

We suspect that there will be another battle before deciding what to do with the asset purchases which seems likely to be made before next summer recess. The ECB seemed to resist calling the reduction of asset purchases as tapering because its extraordinary policies are much more than just the balance sheet. The ECB's monetary policy includes the negative 40 bp deposit rate, refi operations that are fully allotted at zero interest rate, and relaxing some of its credit quality standards.

In terms of sequencing, the ECB has made it clear through its forward guidance that it will not boost rates until sometime after the purchases end. This is the same sequence the Fed and BOE adopted. It is not clear, though, what are the conditions that will allow the central bank to return competitive refi operations, for example.

Also, it seems that ECB President Draghi may come under scrutiny during the run-up to Italian elections that must be held by the end of May 2018. Last month, Bank of Italy Governor (and Draghi's successor) Visco was embroiled in what seemed to be pre-election jockeying. It looked as if he was going to be replaced at the of his term as there was an attempt to place the blame on Visco for the banking woes. Many of the problems, of course, pre-date Visco and that is how Draghi may be dragged into Italian politics.

Recall that before Draghi was the Governor the Bank of Italy, he worked for a US investment bank and reportedly helped some Italian governments to use derivative contracts to minimize the appearance of debt levels. Reports suggest that during his tenure at the central bank, officials knew that Monte dei Paschi, for example, had used a complex transaction to conceal the loss of the equivalent of roughly $500 mln--two years before prosecutors were informed. There are legalistic issues, of the power of the central bank, and the improper actions by former executives since 2008.