Brexit plays dampener to Draghi’s retreat as ECB faces crisis

Bloomberg

Sintra was never meant to be like this.
The European Central Bank’s annual forum in the luscious Portuguese retreat outside Lisbon, was intended as a laid-back event where central bankers and academic economists can thrash out the theories of monetary policy. Instead, reality has intruded once again, this time in the form of the UK’s shock decision to leave the European Union.
The pain of the British vote, from the market ructions already under way to a possible economic hit to come, threatens to blight the euro-area recovery that ECB President Mario Draghi was counting on after two years of unprecedented easing. That has implications for global growth, meaning he and central-bank chiefs including US Federal Reserve Chair Janet Yellen — if she still attends — may find themselves considering how long they can keep their crisis-era policies in place.
“Sintra is a great opportunity to discuss the potential for coordination,” said Frederik Ducrozet, an economist at Banque Pictet & Cie in Geneva. “The ECB will probably be able to wait and see for some weeks but the horizon for the end of unconventional policies has receded.”

Missing Carney
The extent of those discussions might depend on who feels able to tear themselves away from their desk. BOE Governor Mark Carney has dropped out. He was scheduled to join Draghi and Yellen in the highlight of the forum — a panel discussion chaired by Draghi’s predecessor Jean-Claude Trichet to wrap up the event.
Central bankers united immediately after the result of the British vote. The Group of Seven nations issued a joint statement pledging liquidity measures, and central-bank executives were at a scheduled meeting of the Bank for International Settlements in Basel over the weekend. BIS General Manager Jaime Caruana said he is “confident that uncertainty can be contained.”
It’s becoming a familiar theme that the ECB Forum, started two years ago as a European version of the Fed’s Jackson Hole symposium, sees its intellectual musings overshadowed by more-immediate policy concerns. In 2014 it was the imminent introduction of negative rates and asset purchases in the euro area to fend off the threat of deflation, while in 2015 the Greek debt crisis took center stage.

False Dawn
This time, Draghi had reason to hope Sintra might be the occasion to celebrate the first signs that his policies are starting to bite. He said this month that the conditions were in place for consumer-price growth to return to the target of just under 2 percent in the “not-too-distant” future, after more than three years of falling short.
Analysts questioning whether the ECB has done enough with its three-pronged stimulus of negative rates, long-term loans and a 1.7 trillion-euro (US$1.9 trillion) quantitative-easing programme might find that Brexit has provided the answer.
Market bets show the probability of a cut in the deposit rate at the next policy meeting on July 21 have jumped to about 50 percent, from less than 20 percent. That rate is already at minus 0.4 percent.
Unsurprisingly, bets on a BOE rate cut in July have also surged. Carney said that the central bank will “consider any additional policy responses” that are necessary. The question at the Fed is whether the gradual path of tightening it started late last year has already come to a halt.

Populist Demands
Draghi may use Sintra to repeat his standard line that he’ll do what’s needed to revive euro-area inflation, and that governments must act as well. But the financial and political headwinds to achieving that goal are now substantial.
ECB bond purchases may run into scarcity problems in some countries in 2017, and further rate cuts could squeeze banks’ profitability to the point they throttle credit. Draghi’s key tool of Outright Monetary Transactions, unlimited purchases of the debt of the weakest economies as long as they sign up to a reform program, is unlikely to appeal to governments fearful of a backlash. Populist leaders in France, Italy and the Netherlands have already shown a desire for their own referendums.
“Brexit makes it less likely that a ‘whatever it takes’ response is going to be effective,” said Daniel van Schoot, an economist at Rabobank in Utrecht, the Netherlands.
“It will embolden anti-political movements and this could affect yields in the periphery, something the ECB may have to act upon. The fact is that now politicians may not be willing to comply with reform requests as part of the OMT program — and thus tie the central bank’s hands.”