ECB faces key decision over launch of fresh stimulus
In his final months at the European Central Bank, Mario Draghi has given himself a new mission: to restart economic stimulus in a bid to boost flagging global growth.
The man who in 2012 pledged to do “whatever it takes” to save the euro has little time left to deliver — he is set to step down as the central bank’s president in October and by then, markets and ECB watchers expect, the ECB will have embarked on a fresh round of policy easing.
The question is how quickly it moves, and Thursday’s meeting of the governing council in Frankfurt could be key in determining that timing.
The meeting comes just days ahead of a similarly crucial decision by the US Federal Reserve. Investors expect both central banks — responsible for the world’s two most important currencies — to act at some point in the coming months.
But Mr Draghi faces a dilemma: whether to deploy a fresh package of monetary stimulus now, risking only a shortlived effect on the euro, or wait until September — a delay which could give members of his governing council more time to organise a backlash.
His most obvious stimulus option is to cut the bank’s deposit rate of minus 0.4 per cent even further into negative territory; a more substantial package could include a revamp of the quantitative easing programme under which the bank has bought €2.6tn of government and corporate bonds.
It halted the bond-buying last December amid mounting evidence of an improvement in the eurozone economy. But since then global trade tensions have weighed on the bloc’s manufacturing sector, according to a widely watched business survey published on Wednesday, dragging growth down and raising fears that the weakness could spread to services and hit consumer confidence.
“Given the persistent soft patch and inflation which continues to trend below target we expect that the ECB will embark on a renewed easing of policy,” said Victoria Clarke, an economist at Investec.
But the risk for the ECB president is that taking action before the US central bank’s meeting on July 31 could provoke Jay Powell, his counterpart at the Fed, to push for a more drastic rate cut of 50 basis points, rather than the quarter-point cut that investors expect.
A deeper US cut now could stoke expectations of more action from the Fed over the next 12 months, putting downward pressure on the dollar, which would do eurozone exporters no favours.
The exchange rate has become a political sore point in recent months as US president Donald Trump ramped up his accusations that other countries are benefiting from an overvalued dollar.
Although Mr Draghi has repeatedly insisted that the ECB’s mandate is price stability, not currency devaluation, the euro has recently fallen slightly against the dollar and Mr Draghi would not be eager to see that trend reversed.
While the Fed has space to cut rates — its benchmark rate is at a range of 2.25-2.5 per cent — the ECB has less room for manoeuvre.
“They may conclude that if you have only one round left to fire in the currency war, you need to be careful about when you pull the trigger,” said Richard Barwell, head of macro research at BNP Paribas Asset Management. “The ECB might want to wait to get a clearer idea of whether the Fed is likely to cut rates or slash them before they exhaust the 20-30 basis points of space they have to reduce rates.”
So, rather than cut now, many ECB watchers think the bank will instead hint that it plans to do so in September by tinkering with its message on its policy intentions, known in central bank parlance as forward guidance. Just two of 30 economists polled by Bloomberg expect a rate cut as soon as this week.
At the post-meeting press conference Mr Draghi could also discuss the possibility of introducing a tiered system of rates, to lessen the burden of negative rates on private lenders.
Melvyn Krauss, senior fellow at Stanford University’s Hoover Institution, described tiering as “a no-brainer . . . no doubt it will be introduced by September — and maybe even this week”.
Either way, so great are investors’ expectations of fresh ECB action that much of the market effect is already baked into asset prices. European governments are selling debt at record low yields as anticipation of a QE restart drives up prices.
The consequences are being felt in the real economy: this month a local German bank, or Sparkasse, in Nuremberg said it would close more than 20,000 savings accounts because of prolonged low interest rates.
But have markets overestimated Mr Draghi’s ability to deliver a fresh stimulus effort?
Longstanding critics of QE such as Klaas Knot, head of the Dutch central bank, and Bundesbank president Jens Weidmann muted their dissent earlier this year to improve their chances of succeeding Mr Draghi, but now that Christine Lagarde has been chosen they have less cause to keep quiet.
And in recent weeks policymakers such as ECB executive board member Benoît Cœuré and François Villeroy de Galhau, governor of Banque de France, have sounded lukewarm.
“Even as the curtain comes down on the Draghi show, the market still believes that he is the only game in town,” said Mr Barwell. “There is a huge amount of faith that the council will dance to his tune one more time.”