ECB Haunted by Paradox as Draghi Weighs Risk of QE Signaling

Draghi Weighs Risks of QE Signaling
  • Malta hosts penultimate monetary-policy meeting of 2015
  • Economists say additional stimulus a case of when, not if

Mario Draghi’s challenge on Thursday is to show that he’s readier than ever to step up stimulus, without panicking investors over the euro area’s health.

In the run-up to the European Central Bank’s meeting in Malta, the institution’s president and most of his Governing Council said it’s too early to decide whether to expand their 1.1 trillion-euro ($1.2 trillion) bond-buying program. Yet with economists seeing the need for a fresh boost before year-end, he’ll probably be pressured to provide reassurance that the penultimate monetary-policy session of 2015 won’t leave the ECB behind the curve.

Officials sitting down to talk will have to deal with a complex scenario of mixed domestic economic signals, an uncertain global outlook, and divergent opinions on what’s needed to combat feeble inflation. The paradox for Draghi is that when he holds his regular press conference, he may find himself addressing the risks to the recovery without yet committing to action.

“The ECB seems more worried about the economy yet less inclined to act; markets are more confident in the economy yet expect something will be done,” said Francesco Papadia, chairman of Prime Collaterised Securities and a former director general of market operations at the ECB. “For Draghi, it’ll be difficult to even hint that something was discussed because it would send two messages: ‘Good, they’re doing something, and wait, the situation is worse than we thought.’”

The euro was at $1.1323 at 1:16 p.m. in Frankfurt on Thursday, after falling to $1.1302 in earlier trading -- the lowest in almost two weeks.

QE Predictions

All 53 economists surveyed by Bloomberg predict the Governing Council will keep interest rates unchanged at its meeting near Valletta, one of two each year held outside Frankfurt. The benchmark rate is at 0.05 percent and the deposit rate at minus 0.2 percent, both record lows. The ECB will announce its decision at 1:45 p.m. and Draghi will speak to reporters 45 minutes later.

More than 80 percent of economists in a separate Bloomberg survey from Oct. 9-15 said the ECB will eventually beef up asset purchases. Of those who predict more stimulus, 2 percent forecast an announcement on Thursday, 56 percent see one before the end of the year, and 86 percent say it’ll happen by the end of March. The ECB’s next monetary-policy meeting will be on Dec. 3.

Nine months to the day since Draghi won the battle in the Governing Council to start a QE program, the impact on euro-area inflation is barely noticeable. The rate fell below zero in September for the first time since bond purchases started in March, and even though the ECB president said last month that the effect of cheaper oil on consumer prices would be “transitory,” the concern remains that it’ll become entrenched.

“Inflation will take longer to come back up again, which increasingly points to the ECB doing more,” said Nick Matthews, head of European economic research at Nomura International Plc in London. “From my perspective, it’s more about the timing of when is the most appropriate moment to extend QE, rather than whether they should act or not. There are some strategic factors that could influence the timing of a decision.”

ECB Readiness

One issue policy makers can neither ignore nor influence is the timing of the Federal Reserve’s first increase in interest rates since 2006. Draghi and his colleagues frequently say the ECB and Fed are on diverging paths. Should the U.S. central bank delay tightening because of the slowing global economy, that would up pressure on the ECB to ease. Economists predict the Fed will raise interest rates on Dec. 16.

In the meantime, more than half of the Governing Council has called for more data before deciding on, or even discussing, more QE. The heads of the central banks of Germany, France, Austria, the Netherlands, Finland, Slovenia, Slovakia, Lithuania, Estonia and Malta, plus Executive Board members Yves Mersch and Sabine Lautenschlaeger, have all said in the past month that it’s premature to talk about more stimulus or that the current program is well-tuned.

Executive Board member Benoit Coeure said on Oct. 12 that while it’s too early to make a judgment, “we’ve got to be ready.”

For those seeking comfort, there are signs that stimulus is filtering through to the real economy. Banks are using the liquidity to grant more loans and are easing credit terms for companies, ECB data show. Economic confidence in the euro area and business sentiment in its largest economy, Germany, unexpectedly improved in September, while financial-market volatility tracked across markets around the world by the Bank of America Merrill Lynch Market Risk Index is posting its third straight week of easing, its longest such stretch in 15 months.

Liquidity Risk

Yet manufacturing lost momentum last quarter and unemployment is only slowly retreating from a record high. The ECB will publish new macroeconomic projections in December looking forward to 2017, and will extend that to 2018 in March. Any downward revision may provide the rationale to add stimulus.

Last month, officials forecast growth will accelerate to 1.8 percent in 2017 from 1.4 percent this year, and said inflation would only start to approach their goal of just under 2 percent in late 2017.

Draghi’s oft-repeated refrain is that QE, currently intended to run through September 2016, can be adjusted in size, composition and duration if needed. That may not be so easy.

Germany’s Bundesbank would run into supply shortages of bonds just seven months into any extension of the program, according to estimates by Luca Cazzulani at UniCredit SpA. Increasing the size of monthly purchases from the current 60 billion euros would mean a crunch even sooner.

‘Close Call’

Broadening the range of assets to include more government agencies may provide as much 140 billion euros of volume, according to ABN Amro Bank NV. Including corporate bonds is fraught with political headaches over which company debt to buy. Some analysts have floated the idea of another cut to the deposit rate, though Draghi said more than a year ago that the lower bound has been reached.

“We suspect that the debate at this week’s meeting will focus on the outlook, rather than on instruments,” said Greg Fuzesi, an economist at JPMorgan Chase & Co. in London. “We continue to see the ECB on hold, but regard this as a very close call.”

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