Goodbye, Draghi

Today's news headlines:

• ‘EU keeps UK waiting on Brexit delay, Johnson gears for an election’. The decision of whether to grant the UK a three-month Brexit extension has been delayed, with Boris Johnson eyeing a pre-Christmas election if the deadline is moved to January. European Council President, Donald Tusk, said that he was recommending that the leaders of the EU’s remaining 27 member states back the proposed delay. The likely scenario that has emerged is that the EU will offer the UK a three-month delay with the ability to leave sooner if Johnson’s agreement is passed through Parliament. (Reuters)
• ‘Beijing draws up plan to replace Carrie Lam as Hong Kong Chief’. Following violent protests against her administration, the Chinese government is preparing to replace Carrie Lam with a new temporary Chief Executive. The proposed successor would be installed by March 2020 and remain until the end of Lam’s term in 2022. Beijing hopes that violence will subside following yesterday’s withdrawal of the controversial extradition bill, but will not allow Lam to step down until the situation stabilises. (Financial Times)

Passing the baton

Mario Draghi is making his final press conference appearance as European Central Bank President today, before giving the reins to his successor, the former IMF Chief, Christine Lagarde. His tenure has been exceptional in many ways; he will be remembered for his peerless communication style and an ability to marshal consensus for some very sizable policy moves. However, September’s meeting was a discordant affair where a fresh central bank stimulus resulted in a public backlash by hawkish ECB members followed by a resignation. 

Sabine Lautenschläger, the resigning member of the ECB’s Executive Board and Governing Council, was a former Vice President at the Deutsche Bundesbank and member of the Basel Committee for Bank Supervision. Her criticism was that Draghi had strong-armed the committee into the passage of his policy prescription, which included some unprecedented (for the ECB at least) features like a tiered reserve system, which exempts a portion of member bank capital from the -0.5% interest rate charge. She is not alone in her public criticism either. Many of her Germanic colleagues including the former central bank Governors for Austria, Netherlands, Germany, and an ex-deputy of Banque de France all signed a public letter deriding the policy decision. Often considered the old-guard, these more conservative core member country officials signal that the north/south rift in EU economies is far from dead.

On the one hand, Mario Draghi even agrees with their criticism that additional loosening of monetary policy will lead toward additional asset price inflation and sow potential seeds for the next downturn. Where they disagree is for the urgency of a fiscal policy response. Indeed, Bundesbank President Jens Weidmann has been a staunch opponent of increased fiscal spending—despite a continuous government surplus and an extraordinarily low rate environment—based on a notoriously difficult to measure concept called, output gap. This attempts to quantify the difference between an economy’s current and potential rate of economic growth. When most credible signs of economic growth, inflation, and sentiment point downward, this is a somewhat esoteric defence for national priorities over the EU collective good.

Although two-thirds of the ECB voted for easier policy measures, Mario Draghi’s more full-throated approach can be viewed as serving two ends. Firstly, the admonition for government spending to ease the burden on the central bank isn’t a new one, it’s just more urgent now. At some stage, whispers cease to be productive, and a shout is required to get attention. A second motive could be to take a more combative stance to incite a confrontation with cliquish, old-guard members of the council, thereby saving Christine Lagarde – who is historically aligned with Draghi’s policy approach - from fighting a pitched up-hill battle in the opening days of her new role. According to Bloomberg, Sabine Lautenschläger’s replacement on the council, Isabel Schnabel, ‘is an academic economist with a track record of defending monetary stimulus against attacks from her fellow Germans’. 

Bottom line: No change is expected in today’s meeting, but the scene is set for a change of guard. Our sense is that this is just the latest battle of the conflict, not its conclusion.

GBP/USD

Yesterday was relatively subdued as Cable bounced between the 1.2850 and 1.2900 handles for much of the European session. This was due to a wait and see approach from traders on the next steps in the Brexit process. The pair recaptured the 1.29 level overnight as the prospect of a general election has been regarded as positive for Sterling.

GBP/EUR

Like GBP/USD, the pair spent much of yesterday’s session bouncing between two levels but not falling below key resistance around the 1.1550 mark. Positive French Purchasing Managers’ Index data provided a boost for the Euro this morning, but this was almost immediately cancelled out by poor German PMI data. Traders will now look towards the ECB’s monetary policy meeting later today for clarity on the direction of the Eurozone economy.

EUR/USD

For much of yesterday, the pair traded in a 20-pip range due to a lack of data or significant geopolitical news. This morning’s move to the 1.1160 level on the back of some positive French figures was short-lived, and we’re back trading between two key levels with the interbank Spot around 1.1140. US Durable Goods Orders data will be under scrutiny later after Mario Draghi’s final monetary policy decision at the helm of the European Central Bank.