Draghi’s Europe Looks Healthiest for Years Despite Greece

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Mario Draghi
ECB President Mario Draghi. Photographer: Martin Leissl/Bloomberg

Mario Draghi is trying to make the euro area a hard place to leave.

The European Central Bank president has already primed the region’s economy with a 1.1 trillion-euro ($1.2 trillion) stimulus program to spur a recovery. Now, as negotiations over Greece’s bailout near a possible denouement, he’s linking arms with leaders such as German Chancellor Angela Merkel who want the euro to retain all its 19 members.

When the ECB’s Governing Council meets in Frankfurt on Wednesday, it’s likely to sign off on new economic forecasts showing the revival is on track. The gathering comes two days after Draghi sat down in Berlin with Merkel and other representatives of Greece’s creditors to agree on what the Mediterranean country must do to avoid a default that could splinter the currency bloc.

“The economic situation and outlook of the euro zone is currently better than at any time since early 2011, and we should even be heading for a decision on Greece,” said Christian Schulz, senior European economist at Berenberg Bank in London. “Quantitative easing has already provided insurance against some of the risks, like a Greek self-destruction or fears of premature monetary tightening in the U.S.”

Inflation Improvement

The ECB will announce its interest-rate decision at 1:45 p.m. Frankfurt time, and Draghi will hold his press conference 45 minutes later -- amid tighter security after a protester disrupted the last such event in April. With economists in a Bloomberg survey forecasting that the benchmark rate will be kept on hold at a record-low 0.05 percent, Draghi’s comments on QE, Greece and the economy are likely to be the main focus.

The chief area of good news for policy makers is signs the deflation scare that helped usher in QE is on the wane. The inflation rate in the euro area was positive for the first time in six months in May, rising to 0.3 percent from zero and beating economists’ forecasts. Core inflation, which strips out typically volatile energy and food prices, was 0.9 percent, the fastest in nine months.

Those data will buttress the Eurosystem’s new staff forecasts for growth and inflation. In March, the ECB predicted gross domestic product will rise 1.5 percent this year and 1.9 percent in 2016. Inflation was seen accelerating from zero in 2015 to 1.5 percent next year.

‘Dovish Communication’

Even so, the ECB remains far short of its inflation goal of just under 2 percent, and policy makers consider unemployment, which data on Wednesday showed dropped to 11.1 percent in April, is still much too high.

The Organization for Economic Cooperation and Development cut its global growth forecast for 2015 to 3.1 percent from 3.7 percent, saying investment is lagging and risks are hurting confidence. Still, the euro area is back to making a positive contribution, it said.

Draghi has warned of downside risks for the euro area and said the ECB’s forecasts are contingent on the full implementation of QE. Purchases of sovereign debt, covered bonds and asset-backed securities are intended to average a total of 60 billion euros a month through September 2016.

“A dovish communication is likely to prevail until there is genuine progress on core inflation,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “Projections are not expected to be radically different from those in March.”

Berlin Talks

The OECD cited Greece as one reason for its growth downgrade as debt repayments for the nation loom and talks falter on unlocking international aid.

On Monday night, Draghi, Merkel, International Monetary Fund chief Christine Lagarde, French President Francois Hollande and European Commission President Jean-Claude Juncker met at the German Chancellery to discuss ways to break the stalemate. Greek Prime Minister Alexis Tsipras joined the talks by telephone, Germany’s Bild newspaper reported, without saying where it got the information.

Representatives from the creditor institutions have wrapped up their proposal, an international official familiar with the matter said, asking not to be identified because the talks are private. Tsipras will travel to Brussels on Wednesday to present his government’s own proposal to Juncker.

Bond Volatility

In the meantime, depositors have been fleeing Greek lenders, which are being kept afloat by Emergency Liquidity Assistance from the nation’s central bank with the approval of the ECB.

The Governing Council raised the cap on ELA by 500 million euros to 80.7 billion euros on Tuesday, when its members arrived in Frankfurt. They decided again not to tighten the collateral requirements for the funding. A deeper discount -- or haircut -- on Greek securities pledged as collateral would reflect the rising probability of a government default.

“Changes to the terms of ELA provided by the Bank of Greece are possible, but not likely at this point, unless the negotiations break down completely,” Nordea AB economists Jan von Gerich and Heidi Schauman said in a note to clients. “The ECB is monitoring the situation very closely, but does not want to be the main actor.”

While the euro-area economy has initially followed Draghi’s script, the bond market has been less predictable. After the ECB started buying sovereign debt in March, yields slid to record levels and then rapidly rebounded. The yield on 10-year German government bonds, which fell almost to zero, jumped more than 70 basis points in the three-week period to early May. It was at 0.731 percent at 12:54 p.m. Frankfurt time.

Front-Loading

The speed of the reversal unsettled some ECB policy makers. Markets chief Benoit Coeure said last month that it worries him and Vice President Vitor Constancio said officials are monitoring asset markets more closely.

Still, rising rates are a consequence of any successful economic recovery, and the ECB has chosen to smooth over any volatility from a liquidity shortage during Europe’s summer vacation period by front-loading its purchases. Total buying was 63.1 billion euros in May.

“The ECB is happy with the normalization of long-term rates to the extent that they reflect improving growth and vanishing deflation fears,” said Marco Valli, chief euro-zone economist at UniCredit SpA in Milan. “Draghi will probably sound optimistic about the effectiveness of ECB easing, while making clear that the central bank stands ready to counter any unwarranted tightening.”

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