Gilles Moec Macrocast: Dry Powder: Ready to Fire, or Collecting Dust?

A 25bps cut by the ECB is widely expected for this Thursday, but focus is on the extent to which the central bank will accept to move from pure “data dependence” to some forward guidance, anchoring a regular descent of policy rates to neutral and possibly below. We think the ECB’s statement will explicitly point to a “restriction removal” process on the back of a downward revision of their growth and inflation forecasts, but without elaborating too precisely on the speed and magnitude of such process and maintaining, as always, conditionality. 

The ECB hawks now seem to accept the need to cut, but they call for “keeping some powder dry” to deal with future shocks, and dispute how far the current level of policy rates is from a neutral level. We are uncomfortable with the notion of “dry powder”. This sends the signal the central bank could “run of powder” in the future, while part of its power lies in the market’s belief in its capacity to continuously find ways to support the economy and fight deflation risks. We do not think the ECB will have to use unconventional policy anytime soon but given the level of internal and external political instability the Euro area is facing now, the central bank appears as a rare source of reassurance. It is not the right time to send the signal some weapons in the arsenal will remain under lock and key. Of course, the Governing Council does not know yet to what extent the Trump administration will deliver on its trade war threats, nor how the political system in France and Germany will re-arrange itself. But uncertainty carries an immediate economic cost, which could further depress consumers’ purchasing plans and business investment. 

We review the latest political developments in Paris. The country is heading towards a “special law” which will ensure budget continuity. There are some signals arrangements around a “minimal government” could be found, but of course the underlying public finance trajectory remains in jeopardy. We also look at the November Employment report in the US. We still need to wait for the inflation print, but although it is not our baseline, it is getting less and less difficult for the FOMC to decide that a pause in “restriction removal” is warranted in December.