Mario Draghi’s term as head of the European Central Bank (ECB) doesn’t end until next October, but we are already finding financial media fretting over who will replace him. Meanwhile, some investors wonder how Draghi’s replacement will manage eurozone monetary policy. Will the eurozone be weaker after the ECB chief who promised to do “whatever it takes” to save it saying goodbye? In a related story out of the UK, coverage recently seemed relieved after Bank of England (BoE) Governor Mark Carney agreed to stay on through January 2020, as many observers seemed to fear an earlier exit might imperil the economy during a potentially tumultuous Brexit process. In our view, neither of these events is as impactful as coverage frequently portrays. Individual central bankers’ power over markets—or even monetary policy—isn’t so great as many appear to believe, in our opinion.
Central bank chief turnover often spurs speculation about potential monetary policy changes. But in our view, such changes aren’t guaranteed—nor is predicting them easy. Take the ECB: Its chief—currently Draghi—is just 1 vote on a 21-member panel (or “governing council”).[i] Moreover, ECB voting margins—even on potentially controversial measures—haven’t exactly been razor-thin. For example, the governing council’s July decision to decrease asset purchases under its quantitative easing (QE) programme—in which the ECB purchases long-term sovereign and corporate debt from eurozone banks in the hopes they will boost lending—was unanimous.[ii] Similarly, following the ECB’s January 2015 decision to start QE, a reporter asked Draghi if the governing council’s vote was unanimous. From a New York Times account: “Mr. Draghi hedged. ‘The meeting was unanimous in stating that the asset-purchase program is a true monetary policy tool,’ he said. ‘There was a large majority on the need to use it now,’ he added, such that ‘we didn’t need to take a vote.’”[iii]
Even if predicting Draghi’s replacement were possible today, we think it is folly to predict how his or her views or actions might be different. Central bankers are human, with shifting opinions and interpretations. The facts on the ground change, too. Forecasting monetary policy decisions from all this is a fool’s errand, in our view.
Moreover, it is our opinion that central bankers control a lot less than many seemingly think. Their decisions to raise or lower short-term interest rates or adjust asset purchases typically don’t exert much influence on economic growth, in our view. Many credit Draghi with “saving the eurozone” back in 2012 by instilling confidence the ECB would do “whatever it takes” to preserve the union—then launching QE in March 2015. But eurozone gross domestic product (GDP, a government-produced measure of the economy’s size) resumed growing in Q2 2013, almost two years earlier.[iv] Total eurozone GDP surpassed its Q1 2008 peak as early as Q2 2015,[v] well before we think QE’s supposedly stimulating effects would have hit the economy, since monetary policy changes have historically affected the economy at a significant lag, according to Fisher Investments’ analysis.[vi] Our research also indicates eurozone growth didn’t surge when QE began—nor did it plunge as monthly asset purchases started falling in December 2016.[vii]
In our view, misperceptions about central bankers’ power don’t appear limited to the Continent. In August 2016, Carney announced another round of QE to help bolster the economy in the wake of the Brexit vote. We have since noticed many attributing the UK’s resilience to Carney’s “steady hand” and proactive response to looming economic peril. Yet our research indicates UK growth hadn’t faltered when the new asset purchases began—nor did it after they wound down.[viii] Same goes for the eurozone, in our view.[ix] Despite the lack of a counterfactual—a scenario differing only in that QE didn’t exist, allowing observers to isolate its impact—we are of the opinion that it is a drag on growth rather than a boost. There is a wealth of research on monetary policy that informs our view—specifically, the century-old Quantity Theory of Money[x] and many observations of how interest rates impact the economy. In brief, long-term interest rates move on supply and demand for debt securities. Debt purchases increase demand, pushing prices up. Debt prices move inversely with interest rates, which fall. The key impact here is on banks, which borrow from depositors and one another at short-term interest rates to fund long-term loans. This means the difference between short-term rates and long-term rates—called the yield spread—is a proxy for bank profits. QE narrowed this spread, weighing on banks’ loan profits, discouraging them from lending. Hence, our examination of the data and theory suggests QE was a negative for lending—an important growth input.
Some may fear ending QE is a minefield requiring navigation by an experienced central banker like Draghi. Yet removal of what we think was an economic negative is a plus, not a minus. Further, in America, the Federal Reserve changed heads (from Ben Bernanke to Janet Yellen) whilst the bank slowed asset purchases, eventually ending them. It changed heads again (from Yellen to Jerome Powell) after it began reversing QE by reducing the quantity of assets on its balance sheet. No calamity resulted. Of course, the ECB could move too radically or otherwise err. But that risk exists whether Draghi is at the helm or not.
Since Draghi’s departure is scheduled for after the ECB’s asset purchases end in December 2018, it doesn’t necessarily spell anything for QE’s duration. But in our view, this is more evidence Draghi’s leadership isn’t the only thing propping up the eurozone economy—which appears to be growing nicely today.[xi] Given central bankers’ degree of influence doesn’t seem nearly as great as many appear to believe, we don’t think investors need fret Draghi’s—or any other central banker’s—decision to leave monetary policymaking for greener pastures.
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[i] Source: European Central Bank, as of 11/10/2018.
[ii] “Eurozone economy has strength to stomach QE withdrawal, says ECB,” Clair Jones, Financial Times, 12/7/2018.
[iii] “E.C.B. Stimulus Calls for 60 Billion Euros in Monthly Bond-Buying,” David Jolly and Jack Ewing, The New York Times, 22/1/2015.
[iv] Source: Federal Reserve Bank of St. Louis, as of 11/10/2018.
[x] This theory holds that broad inflation fluctuates based on money supply growth, the pace at which money changes hands (known as the “velocity” of money) and the available supply of goods and services, which exerts a large influence on an economy’s trajectory.
[xi] “Eurozone second quarter GDP growth confirmed at 0.4 percent despite negative trade,” Philip Blenkinsop, Reuters, 7/9/2018.
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