Plumbing issues
- 24 October 2022 (7 min read)
- As the ECB will likely hike by 75 bps this week, focus is on how the central bank deals with excess reserves, with significant ramifications for fiscal policy and financial stability.
- With Boris Johnson out of the leadership race, the shift to prudent fiscal policy is irreversible in the UK in our view
We assume most of our readers ordinarily don’t spend much time thinking about their house plumbing, but we also know from experience that when a plumbing issue emerges it becomes difficult to think about anything else until it is resolved. The European financial system may well be facing one of those “plumbing issues”. While this week’s ECB Governing Council meeting is ostensibly about delivering another hike – we expect 75 basis points, in line with consensus – they may also address their nagging excess reserves problem. As obscurely technical as it may seem, this is major, since remunerating those reserves at a growing deposit rate entails a significant cost to the central bank…and ultimately the governments’ coffers, at a time when the fiscal space is narrowing.
The ramifications for liquidity are not straightforward: while “encouraging” the early unwinding of TLTROs – one of the available levers to diminish excess reserves - would set free a significant amount of bonds at a time of collateral scarcity, moving too fast on Quantitative Tightening would add to already challenging conditions on the bond market. We expect the ECB to choose prudence on the latter and postpone decisions. Yet, we continue to be concerned with the speed at which monetary policy is tightening everywhere, which mechanically raises the risk of financial stability accidents.
The UK has been a source of global stress lately. The market reaction last Friday upon news that a significant number of MPs were ready to back a return of former PM Boris Johnson signalled a preference by investors for a fiscally prudent brand of conservatism which Johnson would have had difficulty embodying, even if he would probably have kept Jeremy Hunt as Chancellor had he won. With Johnson out of the race on Sunday night, the new fiscally prudent stance is solidified, whoever from the two remaining candidates – Rishi Sunak, now the clear favourite, or Penny Mordaunt – wins. They both supported Brexit, but we maintain the view we held last week: with a diminished capacity to steer a lone macroeconomic course, some gradual improvement in the relationship with the EU is now the only workable option.
Disclaimer
This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), 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.
It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date.
All information in this document is established on data made public by official providers of economic and market statistics. AXA Investment Managers disclaims any and all liability relating to a decision based on or for reliance on this document. All exhibits included in this document, unless stated otherwise, are as of the publication date of this document.
Furthermore, due to the subjective nature of these opinions and analysis, these data, projections, forecasts, anticipations, hypothesis, etc. are not necessary used or followed by AXA IM’s portfolio management teams or its affiliates, who may act based on their own opinions. Any reproduction of this information, in whole or in part is, unless otherwise authorised by AXA IM, prohibited.
Issued in the UK by AXA Investment Managers UK Limited, which is authorised and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 22 Bishopsgate London EC2N 4BQ
In other jurisdictions, this document is issued by AXA Investment Managers SA’s affiliates in those countries.
Risk Warning
The value of investments, and the income from them, can fall as well as rise and investors may not get back the amount originally invested.