Draghi: ECB Prepared to Add Stimulus on Deflation Risks

Photographer: Ralph Orlowski/Bloomberg

European Central Bank President Mario Draghi. Close

European Central Bank President Mario Draghi.

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Photographer: Ralph Orlowski/Bloomberg

European Central Bank President Mario Draghi.

European Central Bank President Mario Draghi said policy makers are ready to add to stimulus if the outlook for prices deteriorates, though there are currently no signs of deflation in the euro area.

“We don’t have any evidence of people postponing their expenditure plans with a view to buying the same thing at lower prices, in other words we don’t see what is defined to be deflation,” Draghi said after a Group of 20 meeting in Sydney yesterday. “We are aware of the risks. The Governing Council is willing and ready to take any action in case these risks were to gain strength.”

Economists are divided over whether the Frankfurt-based ECB will increase stimulus to counter the risk of deflation after euro-area inflation slowed to 0.7 percent in January, less than half the bank’s 2 percent target. Draghi said the council will have “the full set of information needed for deciding whether to act or not” by its next policy meeting on March 6 in Frankfurt, when it will publish a 2016 inflation projection for the first time.

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He also spoke at length about signs of economic recovery in the euro zone, saying there are initial indications that confidence is returning and domestic demand is picking up.

Inflation Explanation

“I have to be cautious about this because we are not seeing strong, unambiguous developments,” Draghi said. “We are seeing first signs of a development which, if protracted in time, could gain strength.”

Draghi said the inflation rate fell to similar levels after the Asian and Lehman Brothers crises. The drop in core inflation was mostly driven by the currency bloc’s crisis-hit countries, which was “not entirely unwelcome,” while global price changes for energy and food were also a factor, he said.

“You can explain the present level of inflation,” Draghi said, adding medium-term price expectations are also “firmly anchored at 2 percent.”

ECB Executive Board member Peter Praet said in an interview with Portugal’s Expresso published on Feb. 22 that “weakness in price development is extending to the medium term” and that the central bank has tools to use if its mandate to maintain price stability isn’t being achieved.

Even so, the ECB’s benchmark rate is already at 0.25 percent and a cut may involve taking the deposit rate below its current level of zero, something council member Jens Weidmann described yesterday as “uncharted territory.”

Sterilization Pause

“We don’t know what the reaction would be and what the effect is,” he told Bloomberg News in Sydney.

Weidmann indicated his support for suspending sterilization of the ECB’s historic bond purchases to increase liquidity and help reduce volatility on money markets.

“I wouldn’t rule out pausing sterilization” of purchases made under the now-defunct Securities Markets Program, said Weidmann, who heads Germany’s Bundesbank. “If we’re discussing how to inject liquidity into the market, instead of creating a new instrument, the most straight-forward manner would certainly be just to either pause the absorption operation or reduce them in size.”

Ending the liquidity drain would add about 175 billion euros ($241 billion) to the euro-area financial system.

Draghi said while the ECB’s pledge to keep rates low for an extended period has helped to reduce money-market volatility, halting sterilization is “one of the instruments we’re looking at.”

“We have several instruments for our monetary policy, one of which is what Jens has hinted at,” he said. A worsening in the medium-term outlook for price stability would require a different response. “We look at that, we stand ready to act.”

To contact the reporter on this story: Matthew Brockett in Sydney at mbrockett1@bloomberg.net

To contact the editor responsible for this story: Matthew Brockett at mbrockett1@bloomberg.net

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