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Departing ECB hawk draws red lines for fresh policy stimulus measures

Yves Mersch is preparing to take a final stand as one of the European Central Bank’s dwindling band of conservative monetary policy hawks by resisting any broadening of its stimulus measures to purchase a wider array of assets than it already does.

The 71-year-old is the longest serving member of the ECB’s governing council, which he joined when the central bank was created in 1998, and he has watched with growing frustration as it has adopted an increasingly accommodative policy stance. 

He is stepping down after next month’s monetary policy meeting, at which the ECB is widely expected to further expand the unprecedented array of stimulus measures it has launched this year in response to the economic and financial fallout from the coronavirus pandemic.

The wiry Luxembourger, who was a competitive gymnast until the age of 45, told the Financial Times that he expected the ECB to extend the timeframe of its two main policy responses to the pandemic — the emergency bond-buying programme and its ultra-cheap loans for banks — which are due to expire by the middle of next year.

“Since the consequences of this pandemic probably have a longer duration than foreseen when we took the latest calibration decisions in the summer, an obvious candidate for calibration is the timeline extension,” he said.

However, he pushed back against the idea of broadening the ECB’s €3.5tn asset-purchase programme to target securities that are currently off-limits, such as “fallen angel” bonds — those sold by companies that recently lost their investment grade rating — or bank debt, or bonds with a maturity of more than 30 years.

“There is a second approach, to see whether we should become more targeted or more focused,” said Mr Mersch, who referred to such suggested measures as “untested instruments”.

The challenge for Mr Mersch and other hawks on the governing council — including Germany’s Jens Weidmann, Bundesbank president, Robert Holzmann, Austria’s central bank governor, and Klaas Knot at the Dutch central bank — is that their arguments have largely fallen on deaf ears. Hawks have been sidelined and outnumbered as the ECB has stretched its powers to keep borrowing costs low and stop the pandemic spiralling into a financial meltdown.

They barely protested as ECB president Christine Lagarde orchestrated a “no limits” response to the pandemic, including a €1.35tn emergency bond-buying plan that has shed many of the central bank’s self-imposed restraints.

This contrasts with the loud complaints some conservative council members expressed last year over one of Mario Draghi’s final acts as ECB president: an interest-rate cut and a €20bn-a-month restart of bond purchases. 

Ms Lagarde “puts a lot of importance on being inclusive, on being cohesive”, Mr Mersch said, playing down previous splits on the council as “mostly at the fringes”. He added: “These are natural and even useful confrontations of valid points of views.”

His departure will deplete the hawks’ ranks; he is set to be replaced by Frank Elderson, head of supervision at the Dutch central bank, who has expressed support for the ECB’s ultra-loose policy.

However, as recent coronavirus vaccine breakthroughs point to a likely economic rebound next year, the more hawkish members of the governing council could soon find their arguments gain more traction. 

Mr Mersch outlined areas where they still hope to score victories. First, he argued against calls for the ECB to follow the US Federal Reserve in adopting a form of average inflation targeting, which promises to allow inflation to overshoot after a period of undershooting.

“We have taken note of the Fed decision, but we have a mandate for European circumstances that are different,” he said. “If you want to be well understood you should be simple.”

He also expressed doubt about the idea suggested by several ECB council members that it could — in theory — cut its deposit rate further from its record low of minus 0.5 per cent.

“We have very little knowledge about when the reversal rate would be kicking in,” he said, referring to the belief that once rates fall below a certain level the cuts become economically counterproductive. “However, I also admit that I would rather not test that. My belief is in this respect that confidence of the public in its central bank is something we should not lose sight of.”

Ms Lagarde has said the ECB should examine all options for tackling climate change in its strategic review, which is due to conclude next year. But, like other hawks, Mr Mersch is doubtful about whether a central bank should take the lead on this issue.

“It is not our principal policy mandate [on climate change],” he said. “We have a nudging capacity through the size of our balance sheet to be supportive of those decisions that the people with political legitimacy will have to take. But we cannot substitute for them, that is clear.”

The biggest worry for many hawks is that the ECB will find itself constrained by the rapidly rising debt levels of European governments. That risks leaving the central bank unable to raise rates or stop buying bonds because of the fear that soaring government debt levels could trigger a financial crisis, even if inflation does start to rise above its target.

Describing a “corporate-sovereign-bank nexus” created by the state guarantees many countries have extended to bank loans, Mr Mersch said: “As long as the interest rate is below the growth rate I think the issues of sustainability might not be in the foreground; however we have a mandate to respect price stability and we could not look the other way if there were to be inflationary pressures, which we do not see at this point in time.”


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