European Central Bank Chief Economist Peter Praet warned in an interview with German newspaper Boersen-Zeitung that lower oil prices increasingly risk de-anchoring inflation expectations, indicating that quantitative easing is becoming more likely.
The euro-area could see “negative inflation during a substantial part of 2015” amid a slide in the cost of crude, and the Governing Council “cannot simply look through” that, Praet said in comments published on the ECB’s website today. “Inflation expectations are extremely fragile” and “the risk of second-round effects seems to be greater today than it was in the past,” he said.
ECB policy makers are preparing to consider a proposal for large-scale asset purchases, including sovereign bonds, when they meet on Jan. 22. While Executive Board member Benoit Coeure has said that there’s broad consensus for new stimulus, officials including Bundesbank President Jens Weidmann, as well as German politicians, have railed against the risks quantitative easing would entail.
“It is premature to speculate about the number of colleagues who might take a different view,” Praet said in the interview that was conducted on Dec. 11. “If we had had some interest rate margin left, there would have been a unanimous decision to cut rates,” and “if I were willing to cut rates if that had been possible, then I should not be paralyzed by the fact that the only option is to buy sovereign bonds,” he said.
Broad support in society for any such decision would be “desirable,” he said.
Government bonds are “the only sort of security that has a significant market volume,” he said. “There is not too much to buy on the corporate-bond market and it is concentrated in a small number of countries. Buying bank bonds could raise concerns, because we are also supervisors. Theoretically, we could also always buy indices where you have no control of the composition.”
While the ECB doesn’t see “high” risks of a recession and broadly-based deflation in the euro area, policy makers are “increasingly worried” that “businesses and households are reducing their long-term growth expectations and adapting to weak growth and low inflation,” Praet said. “This is why we are underlining that urgent action is necessary.”
One sticking point in the debate is how to mitigate the risks stemming from any purchase of stressed nations’ debt. Praet outlined three approaches the ECB could take.
One “theoretical possibility” would be to take into account the size of a country’s outstanding debt, he said. While that would create less distortion in the market and have a bigger impact on inflation, it would also entail a higher degree of risk-sharing and moral hazard. Other alternatives are buying without loss-sharing in the event of default, or minimizing risks by purchasing only the safest assets, he said.
The prospect of renewed political turmoil and another bond-market rout in Greece, the country that triggered the debt crisis in 2009, has risen as snap elections in a few weeks could put anti-austerity party Syriza in power.
“The rise of populism should be a wake-up call,” Praet said. “Populist parties in some countries promise quick solutions -– but they offer only recipes for disaster.”