With the EU having agreed another Brexit extension this morning (which we expect will keep sterling relatively calm), our focus this week shifts to another event scheduled for Friday… Christine Lagarde’s first day as President of the European Central Bank.

Lagarde takes the reins from Mario Draghi, the man widely credited with saving the Euro at the height of the Greek crisis in 2012, with his “whatever it takes” speech. During Draghi’s tenure, the ECB has slashed interest rates and maintained a negative deposit rate for the past five years, while also employing an asset purchase scheme that many thought would be impossible to implement.

Lagarde’s first challenge will be to sort out the infighting amongst ECB policy makers that has arisen following Draghi’s latest round of stimulus. The governing council elected to cut the deposit rate by 10bps (to -0.5%) and expand its holding of financial assets by a further €20 billion per month. In response, Sabine Lautenschlager, Germany’s representative on the ECB
executive board and a well known hawk, resigned in disagreement with the decision. Trying to keep 19 member countries happy with one policy is always going to be nigh on impossible, but Lagarde will need to find a way to keep the bloc united.

Lagarde’s second challenge will be even more difficult. Over the past couple of years, there has been growing concern about slowing global growth. A glance at the chart below shows a worrying trend across the US and Europe and seemingly justifies the recent policy adjustments from Powell and Draghi.

Lagarde’s second challenge will be even more difficult. Over the past couple of years, there has been growing concern about slowing global growth. A glance at the chart below shows a worrying trend across the US and Europe and seemingly justifies the recent policy adjustments from Powell and Draghi.
The IMF warned earlier this month that the world economy is in a precarious situation and cut its forecast for global growth to the lowest level since 2008 citing uncertainty created by the US / China trade war and Brexit. The export driven German economy has been particularly hard hit and following a quarter-on-quarter reading of -0.2% in Q2, now sits on the brink of recession.

However, after a decade of record low interest rates and complex quantitative easing programmes, the success of which is an ongoing debate, many economists believe that central banks are running out of ammunition.

Unlike Draghi and many of his predecessors, Lagarde isn’t a trained economist and has no previous central bank experience. Instead, she’ll have to rely on the team of experts at the ECB for assistance in solving complex economic problems. What she brings to the table is a warmer personality and greater managerial skills which could help unite policy makers and politicians. Although central banks should remain independent from politics, there is a growing belief, particularly from central bankers, that politicians need to be more active with fiscal stimulus rather than rely on monetary stimulus from central banks.

If successful, an increase in fiscal stimulus, coupled with a reduction in monetary stimulus, should in theory be positive for the euro. Clearly any shift in approach will take some time – Lagarde will need to convince politicians, who are fearful of large budget deficits, that an injection of fiscal stimulus is needed – but it could signal a change in fortune for the single currency in the years ahead. In the short term, its likely to be business as usual. In a recent interview with CBS, Lagarde was quoted saying “there is a limit to how far and how deep you can go into negative territory” before pointing out “there is a bottom to everything, but we are not at that bottom at this point in time.”

From this, we draw the conclusion that there is still scope for additional monetary stimulus, both in the form of lower rates, but more likely additional asset purchases. This is reflected in the OIS curve which suggests a 52% probability of a rate cut by July 2020. For this reason, we remain bearish on the euro in the short-medium term.