The creme de la creme of global central banking is heading to Jackson Hole, Wyoming, for a long weekend. In addition to indications on the further monetary policy course, longer-term directional statements are occasionally made at this symposium. Last year ECB (Schnabel) focussed on its "robust control approach" for fighting inflation. This time, we expect fewer surprises, especially since markets have had to come to terms with the "high for longer" outlook in recent weeks.
This year has been a real roller coaster ride so far. While it started with euphoria after the worst-case scenarios concerning the energy crisis did not materialize and China's end to its zero-COVID policy, disillusion has now replaced the high hopes that accompanied China's reopening. Data in Europe and China lag behind expectations and fail to meet forecasts. The dollar and Swiss franc traditionally benefit from this environment, while the euro and yuan, as cyclical currencies, lose momentum. In Russia and Hungary, disappointing fundamental data also resulted in a weaker performance of the national currencies. The Serbian dinar defied this. Although geopolitical risks and economic data would actually argue against the dinar, foreign currency inflows continue to support it.
This issues features:
The ECB is currently working on an updated operating framework with respect to central bank liquidity. It's fair to say that there won't be a way back to the pre-2008 framework of scarce-liquidity. But also within an ample-liquidity framework the ECB has different options at hand. By analysing the variants which have been implemented by the Federal Reserve and the Bank of England, we draw conclusion for the ECB. We judge that the ECB's bond portfolio will remain the dominant source of central bank liquidity and ensures ample liquidity for the euro area as a whole. Yet, there might be a renaissance of main refinancing operations to provide marginal liquidity to account for the uneven distribution of excess reserves. In this setting short-term money market interest rates would continue to be firmly anchored and trade below the main refinancing rate, yet at higher spreads to the deposit rate as excess liquidity is declining from currently elevated levels.
On the margins of the ECB meeting in July, the ECB announced to reduce the interest rate on minimum reserves to 0%. While having little monetary policy relevance, this step has sparked discussions of whether minimum reserve policies will be adjusted further. Particularly in light of the large level of excess liquidity, the option of increasing the reserve ratio has been discussed. While this mechanically reduces excess liquidity, it is hardly a game-changer to the monetary stance. Further, we believe the ECB will operate within a framework of excess liquidity also in the future, and we don't see liquidity providing policies to become restrictive (in contrast to key rate policies). Minimum reserves, thus, won't be binding, also mid-term. This being said, among euro area member states some redistribution of excess liquidity will be necessary as Italian banks cannot finance maturing TLTROs from excess liquidity. We discuss some options of how this redistribution might take place.
As expected, the ECB raised key interest rates by an additional 25 basis points but did not pre-commit to a rate hike in September. This represents a new phase in which interest rate decisions are to be truly data-driven. The tightening of financing conditions and its negative effects on demand were particularly emphasized. And it is probably this perspective that has to be balanced with the upcoming inflation data.