- European Court of Justice says OMT is legal, with few meaningful restrictions…
- …giving the ECB freedom to design QE how it sees fit and to announce it next week
- US retail sales disappoint, but outlook for consumer demand is bright
OMT legal ‘in principle’
The European Court of Justice came to the initial conclusion that the ECB’s Outright Monetary Transactions (OMT) programme is legal. This removed one of the last obstacles to the central bank broadening its asset purchases to include sovereign bonds. In a non-binding opinion, an advocate-general at the ECJ, concluded that the programme was compatible in principle with the European treaty. The OMT’s principle aim was to provide a conditional safety net by unlimited purchases of government bonds. There was therefore market concern that restrictions on that programme would translate into restrictions on QE.
ECB must have ‘broad discretion’
The advocate-general made a strong case that courts should not be interfering with the central bank. He observed that ‘the framing and implementation of monetary policy are the exclusive competence of the ECB’. In addition, he noted that the ECB must have a ‘broad discretion’ in monetary policy, and that the courts must ‘exercise a considerable degree of caution when reviewing the ECB’s activity’.
Few conditions or restrictions
The ECJ did not lay any meaningful restrictions on the extent or design of the OMT. The conditions it set out will also therefore not have any material impact on the way the ECB intends to conduct QE. It made it clear that the ECB was only allowed to buy bonds on the secondary market, but this is already widely known as it is very explicitly forbidden in the treaty. In addition, the opinion stated that ‘in the event of the OMT programme being implemented, the ECB must…refrain from any direct involvement in the financial assistance programme that applies to the State concerned’. This means it could no longer be part of the troika.
The green light for QE and a victory for Draghi
Although this represents only an initial opinion, in practice it has tended to be a very good guide to the ECJ’s judgment, which will follow in the next few months. We therefore see it as giving a green light for the ECB to announce a QE programme next week. It is also a personal victory for Draghi, who has championed the OMT and QE against fierce Bundesbank opposition.
A blip in December’s US retail sales
After a few months of strong retail sales readings, the December outcome was much weaker than expected. Headline retail sales fell 0.9% in December down from 0.4% the previous month, mainly as a result of plummeting gasoline prices. The more important core retail sales series, which excludes gasoline, building materials and food services fell by 0.4% after a 0.6% gain the previous month. We don’t think that this report is representative of how consumers are doing.
Consumer fundamentals point to strength going forward
Indeed, consumers are now more positive boosted by the strong recovery of the labour market. Employment has been showing broad gains over the last few months, while unemployment has declined beyond market expectations. Job openings suggest that this trend will continue going into 2015. This is supporting income as well as sentiment. The labour market component of the Conference Board’s Consumer Confidence Index, ended last year at the strongest level since 2008. The diminishing slack should start to put upward pressure on wages. We expect moderate gains in wages in 2015 that will likely support consumption. Moreover, falling gasoline prices and rising wealth have propelled consumer confidence further, as well as purchasing power. All these positive developments have already started to translate into stronger consumer spending. Third quarter GDP was mainly driven by strong consumption and economic conditions have become more favourable since then. We expect consumption to remain strong going forward.