Two Takeaways From ECB Record

The record of the ECB's December meeting was released, and there are two takeaways. The first is that officials may have been more concerned with the deteriorating situation than they let on at the time. Apparently, paring near-term growth forecasts was seen as a sufficient signal that risks were increasing. This allowed Draghi to maintain the "broadly balanced" risk assessment.

Although Draghi did acknowledge that the balance of risks was moving lower, it would have been awkward to have been more explicit and at the same time, confirm the end of the asset purchases, which means monetary policy was becoming somewhat less accommodative. Most of the subsequent economic data has disappointed, though EMU unemployment slipped below 8% in December for the first time in a decade. Consider the erosion in consumer and business confidence. The composite PMI is fell to four-year lows. Both German and French industrial output collapsed in December. The German economy contracted in Q3, and the recovery in Q4 looks faint, though retail sales have been stronger.

ECB officials anchor their expectations of underlying inflation to wages, especially in the service sector. Core inflation was steady in December at 1.0%, while the headline pace fell to 1.6% from 1.9% (peaked in October at 2.2%, the highest since October 2012). This tells investors what to focus on if the ECB is going substantially change its outlook.

The second important takeaway is the confirmation that a new (third) Target Long Refinance Operation (TLTRO) is under consideration. At the press conference after the meeting, Draghi said he was "reflecting" on it. The record of the meeting indicated it was discussed. Spanish and Italian banks were the largest users of TLTROs. The first two rounds were for a net total of 730 bln euros.

The first (~390 bln euros) do not come due until June 2020, but pressure will begin being evident around the middle of this year. Under the new regulations, when the loan has less than a year left, it starts to be counted toward the net stable funding ratio. The rules are designed to encourage banks to rely less on short-term funding, A new round of these four-year loans at negligible interest rates can be offered at the end of Q2 or early Q3.

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Read more by Marc on his site Marc to Market.

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