Investment Institute
Macroeconomics

Leaky Pipes

  • 10 July 2023 (5 min read)

  • “Non-decisive” dataflow shifts the emphasis to the duration of restrictive monetary conditions: a “plateau” rather than a “peak.” It can still be painful though as the long end of the curve is adjusting.
  • The Euro area’s complex “pipeworks” – the ESM and the ECB’s balance sheet – are calling for attention again.

The absence of any smoking gun in the recent dataflow in the US, either pointing at “runaway inflation” or conversely at a hard landing of the real economy, is supporting the new emphasis put on the length of time monetary policy conditions will be kept restrictive, rather than on how much further the tightening needs to go. A plateau rather than a peak, to borrow words from Francois Villeroy de Galhau. Being patient and gently but surely taming inflation by maintaining restrictive conditions for longer than initially expected but without going into stratospheric territory can help mitigate financial stability risks. While such an approach may be optimal from a macro point of view, it can still be painful marketwise, as even the long end of the curve is adjusting to the idea of central banks keeping rates significantly above equilibrium possibly over several years.

Tough monetary conditions for long will test the Euro area’s institutional set-up. The monetary union (EMU) operates as a very complex and evolving set of “pipe-works”. 10 years ago, the sovereign crisis triggered much institutional creativity, and the European Stability Mechanism (ESM) was a key source of progress. The current dispute around its reform, revived by Italy, is a reminder that EMU is still in a state of flux. We explore here what the decision by Rome to postpone the ratification of ESM 2.0 reveals about the dividing lines across the union.

Still, the Eurosystem – the ECB combined with the national central banks – is EMU’s most important pipework. The massive growth of its balance sheet is what kept it together. Yet, the legacy of QE – massive deposits at the Eurosystem now paid a substantial rate - is also taking the form of significant income loss for the central bank, and ultimately governments. With the bulk of the contraction brought by the early repayment of the TLTRO now executed, we explore other avenues to shrink the balance sheet. The most obvious option – bringing forward the end of the reinvestment of PEPP – would come with some financial stability risks.

Related Articles

Macroeconomics

What will it take?

Macroeconomics

Letter from China

Macroeconomics

Saved by Supply

    Disclaimer

    This website is published by AXA Investment Managers Australia Ltd (ABN 47 107 346 841 AFSL 273320) (“AXA IM Australia”) and is intended only for professional investors, sophisticated investors and wholesale clients as defined in the Corporations Act 2001 (Cth).

    This publication is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.

    Market commentary on the website has been prepared for general informational purposes by the authors, who are part of AXA Investment Managers. This market commentary reflects the views of the authors, and statements in it may differ from the views of others in AXA Investment Managers.

    Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.

    All investment involves risk , including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested.