The escalating war of words between Germany, initially launched by Deutsche Bank two days ago, which led to a vocal response by Mario Draghi who urged European governments to boost fiscal stimulus (even as he was buying junk bonds), just took a sharper turn today when both Bundesbank President Jens Weidmann and German finmin Schauble warned that the extended period of low European Central Bank interest rates – something which is now a given for years to come – could increase the risk of a “sudden surge in risk premiums”, i.e., a steep selloff in bonds, and that according to Weidmann “policymakers should consider the implications of financial imbalances.” Translation: the Bundesbank is warning the ECB it is inflating another massive asset bubble and has no contingency plans whatsoever how to deal with it.
Weidmann’s comments coincided with German Finance Minister Wolfgang Schaeuble and another senior lawmaker in Chancellor Angela Merkel’s conservative party renewing their criticism of the ECB’s ultra-loose monetary policy. The ECB’s key rate is expected to stay deep in negative territory for years, which coupled with the central bank’s launch of corporate bond buying, is increasing risk-taking and inflating asset bubbles as investors are forced to turn away from fixed-rate securities to seek returns.
As Reuters notes, this has raised concerns that bubbles could burst or that the eventual end of ultra-loose policies could trigger a sudden market reversal. But policymakers have tended to play down stability concerns, arguing that no bubbles are evident for now and the ECB’s main task is to meet its inflation objective.
“They (asset managers) might become increasingly nervous the longer monetary policymakers try to maintain the low-interest-rate policy,” Weidmann told a conference. “This, in turn, could raise the probability of a sudden hike in risk premiums, the longer that forward guidance is in place and the more aggressively quantitative easing is pursued.”
Weidmann added that the ECB should not ignore the potential market exuberance created by its exceptional stimulus because the macroprudential tools meant to fight such imbalances were new, incomplete and not fully understood. He forgot to add that they are completely and utterly useless, since both the ECB and the Fed’s mandate is to create asset bubbles (and thus trickle down inflation), not contain them. In this regard, recent history is the best guide.
“While I am not in favour of a dual monetary policy mandate, I am convinced that monetary policy cannot stand on the sidelines when financial imbalances build up,” said Weidmann, who sits on the ECB’s Governing Council. “Monetary policy would be wise to take the implications of financial imbalances for price stability into account.“
He said the first defence against imbalances should be strengthening banks, and called for new regulations to discourage lenders from holding debt of other financial institutions that was subject to bail-in rules. He was, of course, implicitly referring to the ongoing slide in the Deutsche Bank, where the market is the clearest arbiter of just how bad things are for European financial insitutions.
As Reuters adds, the ECB has faced intense criticism from German politicians, who have complained that ultra-low rates are creating a “gaping hole” in savers’ finances and pensioners’ retirement plans as returns have dropped. “The German government thinks low interest rates should remain a temporary phenomenon,” Schaeuble was quoted as saying by the daily Handelsblatt in its Friday edition. He will be disappointed, especially since with over $10 trillion in global bonds yielding negative, the VaR shock from an abrupt change in ECB policy would lead to trillions in MTM losses across the global financial industry.
He said the government was monitoring the negative effects of low interest rates.
Ralph Brinkhaus, deputy parliamentary floor leader of Merkel’s conservative bloc, told Deutschlandfunk radio that the ECB had “pretty much stretched” its mandate, in the process eroding Germany’s trust in it.
And now we await for the ECB to lower rates even more just to “prove” to Germany how very much in control Mario Draghi really is.
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