Draghi Reshapes ECB Crisis Pragmatism as Trichet’s Dogma Fades
Mario Draghi defied his own staff at his first meeting as European Central Bank president and voted to cut interest rates. As the crisis rages on nine months later, he is shaping the institution more and more in his own image.
Last week Draghi signaled he is willing to take the ECB further than his predecessor, Jean-Claude Trichet, in building a firewall around Spain and Italy. Earlier last month, he jettisoned Trichet’s mantra that senior bondholders at crippled banks shouldn’t suffer losses.
Together with three interest-rate cuts taking borrowing costs to a record low, more than 1 trillion euros ($1.2 trillion) in bank loans and a looser collateral framework, such shifts show pragmatism and a more flexible approach has taken hold at the ECB, said economists from UniCredit Bank AG to Berenberg Bank. Now Draghi is trying to win consensus across governments and central banks for a plan to shore up the region’s bond market that could be announced as soon as tomorrow after he chairs the ECB’s Governing Council meeting.
“The ECB has become more pragmatic under Draghi, many taboos have been shed and precedents set,” said Christian Schulz, a former ECB economist now working for Berenberg in London. “There are a number of reasons for that: the crisis has escalated to the level that the tools devised under Trichet are just not sufficient anymore, and a less dogmatic board also helps.”
Draghi, 64, is himself fostering the image of a new approach. He told Le Monde newspaper in an interview published July 21 that the ECB doesn’t have “any taboos.” Five days later, he sparked the biggest drop in seven months for Spanish 10-year bond yields as he warned investors not to bet against the ECB’s resolve to curb surging Italian and Spanish borrowing costs.
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” Draghi said. “Believe me, it will be enough.”
An ECB spokeswoman declined to comment.
Draghi came to the ECB with a resume that differed from Trichet’s in one key aspect. While both forged their careers in the Italian and French civil services and went on to run their Treasuries, Draghi also spent more than three years at Goldman Sachs Group Inc. (GS) and sat on its global management committee.
Draghi joined the ECB’s six-member Executive Board and became president at a time of flux, with four members arriving in the past year alone.
Draghi and other new officials “are more open about the options available, so it increases the probability of good policies,” said Erik Nielsen, chief economist at UniCredit in London. When Trichet was in charge, “there was a view that certain things just ‘won’t happen’ and that was that. That led to some of the U-turns and we are likely see fewer of those under Draghi.”
Draghi set the tone for his tenure at his first meeting as president of the ECB’s 23-member Governing Council on Nov. 3.
Then as now, Spanish and Italian bond yields were close to euro-era records, Greece was considering a potential euro membership referendum, and pressure was mounting on the ECB to cut interest rates and print money to put an end to the turmoil.
As Governing Council members prepared for the meeting, the ECB’s economic staff advised no change in the interest rate, which was then at 1.5 percent. As the conversation moved around the table, consensus among the 23 central bankers began to emerge towards a cut in the benchmark to 1.25 percent, according to two people present, who declined to be named because such meetings are private.
Draghi refrained from showing his hand until late in the meeting, contrasting with Trichet’s habit of steering the discussion from the outset. Finally, he announced his support for a quarter-point cut, surprising those around the table, and all but four out of 55 economists in a Bloomberg News survey who predicted no change.
Since then, Draghi has cut the benchmark further, taking it to 0.75 percent, and reduced the return that banks get for overnight deposits to zero for the first time ever.
“Draghi seems a little bit more flexible on changing rates, including taking the deposit rate down to zero and refinancing below 1 percent,” said Julian Callow, chief European economist at Barclays Plc in London. “So he is already proving a little more flexible, in my view, and perhaps could be even more so.”
As officials head to Frankfurt for tomorrow’s decision, the stakes are at least as high as they were in November.
Bonds surged after Draghi’s comments last week and investors now expect him to flesh out a coordinated plan with governments to shore up Spanish and Italian bonds.
The proposal involves Europe’s rescue fund buying government bonds on the primary market, buttressed by ECB secondary-market purchases to ensure transmission of its record- low interest rates, two central bank officials said July 27 on condition of anonymity. Further ECB rate cuts and long-term loans to banks are also up for discussion, one official said.
The risk is that Draghi disappoints investors and sparks a selloff that leads to more turmoil, said Athanasios Orphanides, who sat on the Governing Council until May.
Draghi’s comments in London were “not so much a verbal intervention but a threat to the markets that if they don’t stop attacking Spain, they will end up losing a lot of money,” he said. “Expectations are so high now, the ECB will have to announce something.”
Draghi has wrongfooted investors before. A month after taking charge, he appeared to suggest the ECB would ramp up its government-bond purchases if European leaders agreed on the then-novel idea of a fiscal compact. That prompted Italy’s 10- year bond yields to plunge, only for them to jump again when Draghi said he was “surprised” at how his comments were taken.
Trichet also got himself into a tangle over bond purchases. On May 6, 2010 he sparked a selloff when he brushed off speculation that the ECB would embark on a bond-purchase program. Four days later, the ECB unveiled just such a policy.
Draghi has tried to avoid missteps in an extremely fluid crisis environment by not boxing in his options. Trichet often staked out his position early on issues such as refusing to countenance International Monetary Fund participation in Greece’s bailout out or ruling out changing the ECB’s collateral framework to help Greek banks secure access to funding. As the crisis worsened, he was forced to abandon those positions.
Under Draghi, the ECB has been more flexible. In May, Executive Board member Joerg Asmussen signalled in an interview with Handelsblatt that Greece might have to leave the euro, a notion that Trichet always ruled out.
Last month, the ECB ended its opposition to forcing losses on senior bondholders in euro-area banks, another policy fiercely resisted under Trichet. The ECB supported such a move at a meeting of euro-area finance ministers on July 9, according to an official with knowledge of the ECB’s thinking.
A euro-region finance minister, who spoke on condition of anonymity because his discussions with Draghi are private, said the ECB president is more creative in implementing his mandate than Trichet.
At the same time, Draghi’s predecessor was ready when necessary to push the ECB into new territory. He was the first global central banker to react to the seizing up of credit markets on Aug. 9, 2007 and he initiated the ECB’s unprecedented bond-purchase program.
“Let’s not forget that Trichet proved to be very ’pragmatic’ in steering through the Securities Markets Program in the teeth of German opposition,” Barclays’s Callow said.
Change of Guard
Draghi’s promotion to the ECB presidency has coincided both with a wider change of personnel at the institution and an intensification of the crisis that demanded more pragmatism, said Orphanides, who will start teaching at the MIT Sloan School of Management in September. Asmussen, Benoit Coeure and Peter Praet have all joined the Executive Board in the past year.
“Maybe the change in composition has softened the board a little bit and made changes easier,” he said.
Draghi might still succeed more than Trichet did in prodding governments to participate in crisis fighting rather than relying solely on the ECB, said UniCredit’s Nielsen, a former Bank of Denmark official who has been monitoring the euro project since its inception.
“Draghi’s relationship with Europe’s politicians is probably better than Trichet’s,” Nielsen said. “Trichet had a habit of lecturing them. Nobody really likes that.”
Draghi has secured endorsements of key leaders for his crisis-fighting strategy. German Chancellor Angela Merkel and French President Francois Hollande echoed Draghi’s language after a telephone conversation on July 27. The two largest euro- area economies are “bound by the deepest duty” to keep the currency bloc intact, they said in a joint statement.
One challenge for Draghi is just as daunting now as it was under Trichet: getting the Bundesbank to support the most radical measures devised to fight a crisis headed for its fourth year. Former Bundesbank President Axel Weber and former ECB Chief Economist Juergen Stark both quit in protest at the institution’s first round of bond purchases. Weber’s successor, Jens Weidmann has upheld opposition to the measure.
The speech in London will “not have helped the relationship with the Bundesbank,” said Schulz at Berenberg.
Frank Schaeffler, a lawmaker in the Free Democrat party in coalition with Merkel, said Draghi’s policies question his inflation-fighting credentials.
‘Dove in Hawk’s Clothing’
“Draghi was sold to the Germans as a hawk,” Schaeffler said in an interview. “Now it becomes more and more evident that he’s steeped in the Italian monetary policy traditions. He’s a dove in hawk’s clothing.”
Schaeffler’s remarks signal the challenge Draghi still faces in convincing officials from Germany, Europe’s biggest economy, to play ball with his crisis response.
“Draghi can be as pragmatic as he wants to be, but he is still facing the same nightmare as Trichet in terms of getting the Germans on side,” said James Nixon, who used to work for the ECB and is now chief European economist at Societe Generale in London.
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