What does Christine Lagarde, as ECB president, need to do to tackle Europe's stagnant growth? (Part II)

Second instalment of our special Big Question

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In the second of our special look into Christine Lagarde's appointment as the new European Central Bank president, eight executives tell Investment Week what she needs to do to revive Europe's economies.

Photo: IMF Photo/Stephen Jaffe/Flickr CC BY-NC-ND 2.0
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Mike Bell, global market strategist at JPMorgan Asset Management
 
With the eurozone economy slowing, Christine Lagarde's priority should be to keep government borrowing costs low, no matter what, so that fiscal policy can play a role in supporting the economy. To do this, she could clarify to the market that the ECB does not have a limit on the percentage of a government's debt that it is willing to buy, or that the limit is 50% rather than 33%. 

Failing that, she could announce that the ECB is willing to buy government bonds in proportions that are not determined by the capital key, allowing them to buy more of the most indebted governments' debt, to keep borrowing costs low even if growth weakens further. 

If she can keep borrowing costs low for governments then governments must pick up the baton and deliver sensible and responsible fiscal stimulus targeted at boosting growth and long-term productivity. 

Lagarde could use her diplomatic skills to play a role in encouraging those governments which can afford it to provide the right type of fiscal stimulus.
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Carmine de Franco, head of fundamental research at Ossiam

Christine Lagarde may not be an economist, but she has a proven track record as a politician and chairman of the International Monetary Fund. The political skills she brings to the post may be of greater use to build consensus and achieve policy goals than Mario Draghi's technical abilities.
 
Unfortunately for eurozone growth, there is very little she can do apart from maintaining accommodative credit conditions. After eight years of low interest rates and quantitative easing (QE), the ECB is running out of ammunition. 

Europe's growth problem has to do with low investment, low productivity, relatively low R&D in sectors such as technology, rigid labour markets and declining demographics. These are not easily reshaped by monetary policy.
 
We expect her to be a vocal proponent of fiscal expansion and eurozone policy coordination. She is in favour of a larger, more powerful and countercyclical eurozone budget. 

Eurozone growth is ultimately in the hands of European governments and the European Commission, but its fate is also strongly affected by global factors, especially the continuing US-China contest.
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Nikki Howes, investment associate at Heartwood Investment Management 
  
Christine Lagarde has so far supported Draghi's position on monetary policy and has also urged a reform of Europe's budget rules, calling for changes that would incentivise member countries to save more in the good times for use in the bad. 

There is already a broad debate in Europe over the role of fiscal – rather than purely central bank – policy in countering slow growth and potential recessions as the leading economies lose momentum. 

There are worries too that central banks' ability to battle recessions has been diminished by the current low interest rate environment and that fiscal policy will therefore need to play a bigger role. 
 
With sovereign borrowing costs so low, and likely to stay that way for the foreseeable future, a policy of well-designed fiscal support should be seen favourably by member states, particularly those such as Germany with plenty of fiscal headroom. 

However, Germany is committed to a balanced budget approach to its finances and although it has recently announced some small stimulus measures in the form of green initiatives, it remains resolutely committed to its black zero target. 
 
Lagarde's diplomatic and negotiating skills may well be called upon to advance the case for fiscal policy in enhancing the effectiveness of central bank support and tackling Europe's stagnant growth. 
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Didier Borowski, head of macroeconomic research at Amundi
 
After the latest ECB meeting, it is clear the body is more publicly divided than ever on how best to resurrect the eurozone economy. Christine Lagarde's first task will be to keep discord out of the media, end the public disagreement and build a broad consensus. 
 
While Lagarde is unlikely to reconsider the measures announced in the short term, one final rate cut (-10bp to -0.6%) by mid-2020 is a distinct possibility. 
 
She is well practiced in talking to heads of states, which will be useful in a monetary union made up of still very disparate economies. 

She also enjoys the confidence of investors that she will likely mobilise to encourage more fiscal co-ordination.
 
Not being an economist by trade, she will likely seek to re-establish a consensus within the ECB, and will be unlikely to oppose the monetary policy committee going ahead. 
 
While it would be difficult to abandon the announced measures, the 'open-endedness' of the QE could well be reconsidered at some point. Investors should therefore not consider that the QE is a foregone conclusion for the long term. The ECB commitment to buy bonds may prove more fragile.
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Chris Bailey, European strategist at Raymond James

There is an irony at the heart of Christine Lagarde's accession to the position of ECB president. An independent central bank in the modern world may have a broad range of monetary policy instruments to push and pull, covered by a range of acronyms well beyond the now very familiar QE. 

However, monetary policy can only do so much and growth challenges in the eurozone also need the help and assistance of a looser fiscal policy and a true commitment to innovation enhancing structural reform. These issues were well understood by Draghi who called for the latter in almost every ECB press conference he presided over – but was largely ignored. 

So the real value-add that Lagarde can bring is – using the ECB presidency platform – to channel the experiences she garnered in her previous job at the International Monetary Fund and effectively harangue eurozone governments to complement the continuing ultra-loose ECB policy with expansionary fiscal policy boosts and flexibility improving structural shifts. 

In short, the best contribution Lagarde can make in her new job is to start highlighting its limitations.
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Terry Farrow, senior investment manager at Charteris Treasury Portfolio Managers

As of 1 January 2020, she should declare that the euro no longer exists and that all member countries will switch back to their previous currencies at a rate that they feel meets their economic requirements.

This means that the weaker countries will no longer be tied to a currency that is too strong and the stronger countries have a currency more appropriate to their own economic strength. Interest rates can then be set to the respective county's requirements. No more money creation, artificially low interest rates and preferably debt forgiveness (unlikely).

The German government may need to support both Commerzbank and Deutsche Bank and gradually unwind their grossly overinflated derivatives book.
Italy would also have to support its banks with debt forgiveness. This would probably entail initial hardship but, within a short period, it and other struggling member countries would recover.

The advantage of this action is that the individual countries would be able to claim back control over their economic affairs and govern themselves. Free trade could continue, but would be controlled by the individual country's ability to pay. 

Each individual country would then have its own central bank in control and the ECB could be shut down, saving taxpayer money.
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Mark Holman, chief executive of TwentyFour Asset Management
 
Christine Lagarde takes over from Draghi at what looks like a very difficult time. The global co-ordinated economic slowdown has been developing deeper roots over the past 12 months, and Europe looks particularly problematic – even without a macro shock we would put the probability of a eurozone recession by the end of 2020 at close to 50%.
 
The ECB's September decision to restart asset purchases at €20bn per month was far from unanimous, and in our view the addition of the tiering scheme for bank deposits will require the central bank to expand the QE programme again if it is to have the desired effect. 

It is clear to us that with the move to zero rates (and below), the power of the ECB's extraordinary monetary policy measures has diminished, and it will need support from eurozone governments in the form of fiscal stimulus if it is to revitalise the economy.
 
The key for us will be whether Lagarde can keep the ECB governing council onside, as Draghi has done skilfully on occasions, sometimes even appearing to ignore consensus. 

One topic that Lagarde may also have to address will be helicopter money. Draghi has said that "giving money to people" is a fiscal policy task, not a monetary policy task. Will Lagarde see things the same way?
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In the second of our special look into Christine Lagarde's appointment as the new European Central Bank president, eight executives tell Investment Week what she needs to do to revive Europe's economies.

The former head of the International Monetary Fund became the central bank's first female president, succeeding Mario Draghi on 1 November.

But on her appointment, she inherits a Europe plagued by political turmoil and growing unease towards the single market.

Click here to read part 1 of this two-part Big Question.

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