Mario Draghi is poised for even bolder steps to stave off the threat of euro-area deflation, say economists.
The European Central Bank president’s decision this month to take the deposit rate negative for the first time marked the end of conventional policy measures and he’ll start to buy asset-backed securities within a year, according to more than three-quarters of respondents in the Bloomberg Monthly Survey. Most economists also said interest rates will stay at present levels through at least 2016, though they’re split on whether the ECB will undertake broad-based quantitative easing.
Draghi has repeatedly said policy makers are willing to buy debt from securitized loans to government bonds to bolster inflation and spur the currency bloc’s stuttering recovery. Even so, officials haven’t yet judged the time is ripe for such a radical move, and Governing Council member Jens Weidmann warned last week against the “sweet poison” of asset purchases.
“It is now quite clear that the next step is likely to be an ABS quantitative easing, then followed by a full-blown government-bond QE if need be,” said Alan McQuaid, chief economist at Merrion Capital in Dublin. “There is probably little value in cutting rates any more.”
Draghi’s concern is that ultra-low borrowing costs aren’t filtering through to the real economy, and are failing to drive investment and economic activity. That’s reflected in consumer-price and credit data. Euro-area inflation has been less than half the ECB’s goal of just under 2 percent since October. Lending to companies and households has barely budged in 2014 and is down almost 2 percent from a year ago.
Inflation in May was 0.5 percent, matching the slowest pace in more than four years, according to final figures from the European Union’s statistics office in Luxembourg today.
In the Bloomberg survey, 31 of 33 respondents said the ECB will engage in an ABS-purchase program, with 28 saying it’ll happen by June 2015. Fourteen predicted the ECB will start a QE program at some point, with 10 saying it’ll begin by the middle of next year.
Draghi told reporters after the June 5 policy meeting in Frankfurt that officials will “intensify preparatory work” for potential purchases of ABS, or packaged securities backed by anything from small-business loans to credit-card debt. When asked if the ECB would consider QE, he said: “Are we finished? The answer is no.”
The ECB views QE, or large-scale asset purchases with the aim of boosting the money supply and thereby inflation, as a legitimate option. At the same time, it isn’t an easy one, as the euro area lacks a unified government debt market that would be the obvious target for purchases, making the appropriate assets for an effective QE policy hard to select.
While the 24-member Governing Council says it’s unanimous in its willingness to use unconventional policy measures if needed, Executive Board member Benoit Coeure said last week that there is no current need for QE.
“It is not needed now because we don’t see deflation in the euro zone and we have a deep sense that the measures we decided are appropriate to face the prospect of low inflation,” he said at an event in Dubrovnik, Croatia. “It’s really too early to discuss our next decisions.”
Weidmann, Germany’s representative on the Governing Council, reiterated his concern at the same event that broad buying of assets reduces the pressure on governments to make structural reforms.
“Asset purchases may act like a sweet poison for the governments,” he said. “The rude awakening may come when the purchases are reduced or stopped altogether.”
A smaller ABS program could support credit growth by allowing lenders to spread the risk of their loans, and complement the ECB’s proposed conditional loans to banks. That plan, also announced on June 5, will provide as much as 400 billion euros ($542 billion) as long as banks lend the cash on to companies and households.
Unconventional policies could be necessary because Draghi has little if any room to cut official interest rates further. The benchmark rate was reduced to 0.15 percent on June 5 and the deposit rate dropped to minus 0.1 percent, making the ECB the first major central bank to charge for holding lenders’ excess cash. Draghi said rates are at the lower bound “for all practical purposes” and changed his forward guidance to remove a pledge to cut them if needed.
“If the ECB decides to act again, it will be unconventional measures,” said Duncan de Vries, an economist at Nibc Bank NV in The Hague. “Lowering interest rates alone will unlikely be enough to rekindle bank lending to the private sector in the euro zone’s periphery.”
Just one of the economists in the survey said the benchmark rate would be reduced again and three said the deposit rate will be cut. More than two-thirds of respondents said rates won’t be raised before 2016 and 28 percent said the first increase won’t come before 2017.
Almost 80 percent of economists in the survey said conditional loans will be successful in increasing lending in the euro-area periphery. Still, just 54 percent predicted that banks will make full use of the allowance.
“The question is whether the ECB will see this as a success or as a failure,” said Elwin de Groot, an economist at Rabobank in Utrecht, the Netherlands. “Surely by mentioning the 400 billion euros number, Draghi has created expectations that may prove difficult to achieve.”