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Analysis
Approval for ECB package signals wider alignments

Approval for ECB package signals wider alignments

German-Italian soundings on the future of Europe

by David Marsh

Wed 11 Jun 2014

The Bundesbank’s approval for last week’s European Central Bank (ECB) package of liquidity measures and interest rate cuts into negative territory appears to be part of a wider-ranging realignment of responsibilities on the European scene.

A series of interlinked initiatives could consolidate the position of reformists in key areas of European policy-making, reinforcing still-fragile economic and monetary union (EMU) by eventually installing a German leader at the helm of the ECB.

By limiting the cut in the ECB’s main interest rates to only 0.10 percentage points, and agreeing that rates have now reached their floor in Europe, Mario Draghi and Jens Weidmann, the presidents of the ECB and the Bundesbank, have effectively ended a period of sporadic skirmishing that erupted after they took their jobs in 2011.

The conclusion of hostilities could pave the way for a still more dramatic rapprochement if Weidmann replaces former Banca d'Italia governor Draghi as ECB president in the next few years, as some observers believe is likely if Draghi takes over from 88-year-old Giorgio Napolitano as Italy’s president in Rome.

Matteo Renzi, the new Italian prime minister, is emerging as a pivotal European figure following his more comfortable-than-expected win in last month’s European parliamentary elections. German Chancellor Angela Merkel has fastened on Renzi as a potentially reliable ally in the swirling battle for influence caused by oscillating power struggles between Berlin, Paris, London and other capitals.

In particular, Renzi has close relations with Draghi, contrasting with the ECB chief’s habitual leaning to keep his distance to Italian politicians.

Renzi’s support for a reform-minded president of the European Commission could prove crucial to attempts to prevent Jean-Claude Juncker, the former Luxembourg prime minister and finance minister, who has been given fluctuating backing by German Chancellor Angela Merkel, to take over the Brussels body later this year. 

There is no love lost between the ECB and Juncker, who as leader of the Eurogroup of finance ministers tried to usurp some of the power of Draghi's predecessor Jean-Claude Trichet earlier in the euro’s history.

Renzi will be crucial in machinations for the succession to Napolitano, possibly as early as around the time of his 90th birthday in summer 2015. Draghi is the front-runner to take over, probably before the end of his eight-year ECB term that runs to 2019. The timing would depend on the opening of a relatively calm period in Italian politics and the European economy, conditions that cannot be guaranteed.

A landmark development for the Bundesbank president to lead the ECB would mark a more propitious version of the foiled move in 2010-11 for Axel Weber, then Bundesbank president, to succeed Trichet, the ECB’s second president after Dutchman Wim Duisenberg.

This plan was stymied by the then Bundesbank chief’s uncompromising nature and Merkel’s reluctance to fully back the often irascible Weber in the face of political reluctance, especially from France, to see a German head the ECB.

Weber subsequently stepped down early from the Bundesbank and now chairs Swiss bank UBS. He was replaced by Weidmann, Merkel’s former economic adviser, in May 2011, while Draghi took over from Trichet at the ECB six months later.

Weidmann has taken a far more conciliatory course than Weber towards other members of the ECB governing council, refraining from critical statements and actions in recent months. In particular, Weidmann has made great efforts to patch up his relations with Draghi after having opposed the latter’s initiative in summer 2012 for ECB government bond purchases under the effective but unconsummated Outright Monetary Transactions (OMT) programme.

A combination of Draghi as the far-from-merely-honorific head of state of the country often seen as the euro’s biggest long-term problem, Weidmann at the ECB (he would be replaced as Bundesbank president by ECB board member Sabine Lautenschläger) and a reformist leader of the Commission could be a ‘dream team’ for Europe.

Last week’s ECB measures, although superficially a monetary operation, bear all the hallmarks of a carefully-crafted political compromise. The ECB launched a major strike against threatened deflation through the offer of up to €400bn in cheap, fixed-rate loans – known officially as targeted longer-term refinancing operations (TLTRO).

The euro area’s ‘hawks’ – led by Weidmann and De Nederlandsche Bank President Klaas Knot – achieved their goal of gearing the new facilities as far as possible to providing credit for smaller businesses, rather than allowing banks cheap loans to finance ‘carry trades’ through government  bond purchases. It remains to be seen how targeted and how effective these measures will be.

Many market participants believe that full-scale quantitative easing through ECB purchases of government bonds may soon come under ECB consideration. However part of the compromise is that, whatever the short-term outlook for growth and inflation, ECB government bond purchases are now effectively off the agenda at least until the first few months of next year. With US interest rates expected to rise from the end of the year onwards, the Bundesbank and other leading European central banks will be very cautious about US-European monetary decoupling and will step up their lobbying against any kind of government bond operations. Given Draghi’s own conservative instincts on this issue, government bond purchases in Europe (including enactment of the OMTs) are now extremely unlikely.

The TLTROs announced last week will be conducted in September and December. Draghi said last week in Frankfurt that changes to the real economy attributable to the overall programme would probably need nine to 12 months to work through.

Draghi announced further steps towards ECB purchases of asset backed securities to enhance monetary policy transmission. Under this initiative, euro central banks might purchase ‘simple and transparent asset-backed securities with underlying assets consisting of claims against the euro area non-financial private sector’ as part of further monetary easing. However, this development depends on regulatory changes and is far less sweeping than intervention on government bond markets hotly opposed by Germany, including very publicly by Merkel herself.

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