How would Lagarde as ECB president impact financial markets?
The current managing director of the IMF, Christine Lagarde, has been nominated to become the next president of the European Central Bank. We have a look at what it could mean for financial markets.
It’s all change at the EU. Leaders have tentatively decided who will be the next leaders of the bloc as four of the most important policymaking roles within the EU become vacant later this year.
Meet the EU’s new leaders
- Charles Michel, the current prime minister of Belgium, has been elected as the next president of the European Council to succeed Donald Tusk at the start of December 2019. Michel will hold the post for a two-and-a-half-year term that can be renewed only once (for a total five-year term).
- Ursula von der Leyen, Germany’s defence minister and close ally of Chancellor Angela Merkel, has been nominated to become the next president of the European Commission. She will need to be elected by a majority of the European Parliament and, if successful, will takeover from Jean-Claude Juncker at the start of November 2019 for a five-year term.
- Josep Borrell Fontelles, Spain’s foreign minister, has been nominated for the role of High Representative of the Union for Foreign Affairs and Security Policy, which is essentially the EU’s foreign secretary. He will also need to be elected by parliament and hold the job for five years if successful, taking over from Federica Mogherini at the start of November 2019.
- Christine Lagarde, the current managing director of the International Monetary Fund (IMF), has been nominated to become the next president of the European Central Bank (ECB). She will need to be elected by parliament and would succeed Mario Draghi at the start of November 2019 for an eight-year term.
How is the ECB president elected?
Lagarde’s nomination is the one that has grabbed the attention of financial markets. The European Council will hold discussions about Lagarde’s appointment with the European Parliament and the ECB's Governing Council, which includes Draghi and his team as well as the governors of the other central banks within the eurozone. A majority of council members will have to support her nomination in order to be formally awarded the job.
Lagarde issued a statement soon after her nomination was announced that said she was 'honoured' to be put forward. She has also temporarily suspended her current role running the IMF until she knows the council’s decision.
Who is Christine Lagarde?
Lagarde has been the managing director of the IMF since 2011. The IMF is an organisation that sees 189 countries come together to ensure the stability of the international monetary system. However, it also promotes international trade and economic growth while fighting against the likes of poverty and inequality.
Prior to leading the IMF, Lagarde spent four years as the finance minister of France. Having been appointed in 2007, she took the job just as the financial crisis was beginning to unfold. Before that, she was a lawyer that worked her way up Baker McKenzie to eventually become chairman.
Lagarde is regarded as one of the most prominent women on the world stage. She was the first female leader of the IMF and the first woman to lead the finance ministry of a G7 nation. And her role at Baker McKenzie meant she was also the first female chairman of an international law firm. If Lagarde is elected to lead the ECB, then she will be the first female president too.
Taking over from Draghi
There is never an ideal time to handover the top job at the ECB. Draghi had to handle a debt crisis among European banks when he joined in November 2011 and, after only one month in charge, announced the ECB would loan €489 billion to over 500 European banks after the financial system was knocked by fears that banks weren’t strong enough and that the euro – the single currency – could break up. In July 2012, as threats to the eurozone and its members increased, Draghi made his most famous speech that said the ECB would do 'whatever it takes' to save the single currency. Draghi has won applause for his decisive role in handling the eurozone crisis and developing the ECB into a more influential institution.
But Draghi’s term is coming to an end at a time when many legacy issues still need to be resolved and future threats are building. There are still long-term structural issues for the euro – there still isn’t a common banking union or reserve, despite being widely recognised as the remedies needed to strengthen the currency. There is still a north-south divide, with debt-laden countries like Greece and Italy still harbouring discontent toward the more influential players like France and Germany for the austerity measures they have imposed on them. Global growth is under pressure and firmly pointed to the downside with Brexit lurking around the corner and with trade wars continuing to escalate.
Draghi said the ECB is willing to make further cuts to interest rates and initiate a new programme of quantitative easing (injecting new money into the economy to buy things like government bonds) in order to get inflation to the bank’s 2% target. Inflation was on target in September 2018 but has since seen a dramatic fall to just 1.2% in May 2019. Further comments from the ECB have cemented the view that interest rates are to remain low after it suggested a rate hike won’t be on the cards until the latter half of 2020. The ECB hasn’t hiked interest rates at all over the last eight years.
Lagarde was one of the less likely candidates to be nominated. According to a Bloomberg survey of economists, Lagarde was ranked seventh in the list of most likely successors to Draghi, far behind the favourite Jens Weidmann, who currently leads the German Bundesbank.
One of the reasons she was not considered a strong candidate for the job is her perceived lack of experience in economics. She would be the first president of the ECB not to hold an economics degree. In fact, she was seen as a more likely successor to Juncker as president of the European Commission than the preferred choice to lead the bank.
For her supporters, any perceived lack of understanding of economics is more than made up for by her political influence, and they argue that she has already proven the same sceptics wrong when they doubted her upon being appointed to the IMF.
Some have pointed to the fact that the chairman of the US Federal Reserve (Fed), Jerome Powell, comes from a legal background and lacks formal economics qualifications like Lagarde. But he spent five years within the Fed before taking the top job in 2018.
Merkel, who was reportedly under pressure to push for a German to lead the bank, shrugged off questions about Lagarde’s lack of experience running a central bank by praising her achievements leading the IMF, stating 'whoever can do that can also head the ECB'. Similarly, Dutch prime minister Mark Rutte described Lagarde as a 'tough lady', adding he 'wouldn’t like to be the European country who needs to go to the ECB asking for favours' with her in charge.
The main debate that has been sparked by her nomination is whether Lagarde’s recognised diplomacy and consensus-building approach to solving problems is enough to allay concerns that she doesn’t have the financial head needed to run one of the most important financial institutions in the world. She spearheaded the IMF’s role in several major bailouts both inside and out of the eurozone, including Greece and Argentina. Her role at the French finance ministry at the height of the financial crisis also means her career has had exposure to economic crises.
Still, this will mean Lagarde will have to depend on the rest of the council members to get the technical insight needed to implement new policies. Some commentators have suggested her role will be more about selling new policies to members and gaining broader support among individual nations to allow the ECB to implement the more drastic policies needed to get the European economy back on the front foot. However, it is important to remember that while the president of the ECB leads the bank they are not solely responsible for steering policy. They simply oversee the six-member council, which collectively votes on how to set interest rates or whether to introduce new stimulus. This means Lagarde can bring a new approach to the council but that she must ultimately keep her colleagues onside if she wants to get anything done.
What will be Lagarde’s approach to European monetary policy?
It is not yet known whether Lagarde will be elected as the next president of the ECB, let alone what policies she will adopt if she is. However, most are expecting Lagarde to pick up the baton from Draghi and follow his dovish stance on monetary policy, partly because no one is expecting someone without an economics background to charge in and overhaul long-held policies overnight.
Plus, she has previously supported Draghi and the ECB’s policies, including the quantative easing programme. In a blog written for the IMF in June, Lagarde said she believed the global economy would 'benefit from the more patient pace of monetary normalisation by the US Fed and the European Central Bank'. She added that the current policy of the ECB (and the Fed) had 'provided vital support over the past few months, including by easing financial conditions and increasing capital flows to emerging markets'.
It is therefore unsurprising that many believe it will be business as usual at the ECB if Lagarde is elected, with some suggesting she could launch a new round of quantative easing soon after taking office. But the main message her nomination has sent to financial markets is that interest rates are going to remain lower for longer. That is even more significant considering the favourite for the job, Weidmann, is considered a hawk that would have overhauled the ECB’s policy and pushed for higher interests. Some have suggested a deal was struck between Germany and France that resulted in Lagarde being nominated for the ECB role to give the French a bigger voice in return for von der Leyen’s nomination to lead the commission who, if successful, will be the first German in charge for 50 years. The emphasis that the ECB has put on the diversity of its new leaders in terms of nationality and gender will have undoubtedly swayed in Lagarde’s favour too – she was the only woman considered among the top eight candidates for the ECB role, according to the Bloomberg survey.
Lagarde and the ECB: what does it mean for financial markets?
With investors expecting interest rates to remain low, European stocks benefited. The Euro STOXX50 index – comprised of the 50 largest companies in the eurozone - climbed to its highest level in almost two years. The German DAX and the French CAC 40 also rallied to new highs.
This was fuelled by investors buying into dividend-paying stocks that are more attractive when interest rates are low. Defensive stocks – those that tend to prove more resilient in an economic downturn and often pay dividends – have performed particularly well off the back of the news. For example, the MSCI Europe Healthcare index rose to its highest level since 2016 while the MSCI Europe Utilities index spiked to a new five-year high. Other industries that tend to benefit at times of low interest rates, such as real estate, also received a boost.
The signal that interest rates will remain low also caused most ten-year eurozone bond yields to fall to new lows, with Belgium’s ten-year bond yield turning negative for the first time while German Bund yields, often seen as a benchmark for the wider bloc, fell to -0.399%, touching the ECB’s -0.4% deposit rate, according to Reuters. Italy, regarded as a major beneficiary of quantative easing, also saw yields fall.
What could it mean for forex markets?
The prospect of a looser monetary policy stance at the ECB has done little to dent EUR/GBP upside for now, with the release of three dour purchasing managers index (PMI) figures from the UK going some way to limit any downside momentum for the euro. The weekly chart highlights the precarious position we find ourselves in though, with the wider creation of lower highs expected to kick in once more in the coming weeks. With recent price action taking place around the notable 76.4% Fibonacci retracement level, this does look like a key potential turning point for the pair.
The Bank of England (BoE) are starting to show a slight inkling for a dovish shift given recent economic weakness in the UK, yet for markets it is all about relative differences. Thus, traders should consider whether the shift in BoE rate cut expectations is larger or smaller than at the ECB under Lagarde. The difficulty is the difference in timeframes, with Mario Draghi’s successor only getting their feet under table in October. Nevertheless, we have seen expectations of a 2019 rate cut jump to 49%, from 22% last week. Clearly this shift goes a long way to negating any euro downside. Thus EUR/GBP traders should keep a keen eye out for those BoE and ECB rate cut expectations as the shifting differential impacts the trajectory of this currency pair.
The euro devaluation has been much more evident on the EUR/USD chart, with Monday’s decline leading us into the 61.8% Fibonacci support level. The wider trend appears to be pointing towards another leg of this recovery, with the price having broken higher from a falling wedge pattern in early June. The respect of these Fibonacci levels will be important in gauging whether this is a temporary retracement or the beginning of another bearish leg.
For now it seems the pair could start to turn higher in a continuation of the recent bullish resurgence. However, for now we are likely to see the distant prospect of a moderately more dovish stance from the ECB being overshadowed by the more immediate prospect of a total 75 basis points worth of Fed rate cuts over the next four meetings. Watch for a break below $1.1181 to negate that recent bullish trend.
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