Mario Draghi Is About to Become the World's Market Risk Manager

Draghi to Deliver More Stimulus? What to Expect From ECB
  • ECB seen adding stimulus Thursday as inflation stuck near zero
  • Fed counterpart Yellen could raise U.S. rates two weeks later

Mario Draghi is set to become the new first line of defense for the world economy, whether he likes it or not.

Federal Reserve Chair Janet Yellen’s preparations to raise U.S. interest rates this month put the European Central Bank president in the vanguard of the global charge against feeble inflation. The fresh wave of monetary stimulus that he’s predicted to unleash on Thursday may become the best chance for a much-needed impetus to consumer prices.

While the ECB gears its policy for the 19-nation currency bloc, it may find itself setting the pace for other central banks. That would help keep the worldwide monetary stance accommodative, in an environment where inflation pressures are minimal, even as the Fed tightens for the first time in nine years.

“We see the ECB as now taking on the Fed’s mantle as the primary ‘risk manager’ among global central banks with respect to downside risks” for the economy, said Krishna Guha, vice chairman of Evercore ISI in Washington. “This is a seminal shift.”

Rate Cut

The 25-member Governing Council’s decision on interest rates will be announced on Thursday at 1:45 p.m. in Frankfurt. Draghi will hold a press conference 45 minutes later where he may unveil any further measures.

The ECB has presented policy makers with updated economic forecasts ahead of their announcement that are largely unchanged from those published in September, according to officials familiar with the numbers. It will revise down its 2017 inflation forecast to 1.6 percent from 1.7 percent, one of the people said. An ECB spokesman declined to comment.

Investors expect action at the meeting, pricing in a 100 percent probability of a 10 basis-point cut in the deposit rate from the current minus 0.2 percent, and an 81 percent chance of 15 basis points, according to calculations based on ECB-dated Eonia futures. All economists in a Bloomberg survey published this week said the central bank will add stimulus, with predictions including an extension or expansion of its 1.1 trillion-euro ($1.2 trillion) bond-buying program.

The euro was down 0.5 percent at $1.056 at 12:19 p.m. Frankfurt time. The single currency has declined more than 12 percent this year.

Confident Yellen

In contrast, Yellen said on Wednesday that she’s confident in the U.S. economic outlook and warned of risks if the Fed waits too long before increasing interest rates.

“Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals,” she said.

Even with the euro area’s recovery confirmed by incoming data such as hiring, Guha said Draghi is taking out insurance against inflation staying too low as emerging markets stumble and geopolitical concerns rise. That’s in keeping with how the Fed used three rounds of quantitative easing to guarantee the U.S. expansion.

Fed-Style

“Draghi will ease pre-emptively to firm the recovery and lean against potential downside risks, rather than because the base-case outlook has deteriorated,” said Guha, a former official at the New York Fed. “This is absolutely Fed-style risk management.”

The ECB, like the Fed, designs policy for its own economy. Yet officials showed their concern over spillovers from elsewhere in the account of their last monetary-policy meeting, where they noted the “fragile” international economic environment and the “particularly high ” uncertainty about China.

“He’s not being a global citizen in doing the right policy,” said Marios Maratheftis, chief economist at Standard Chartered Plc. “He’s doing the right thing for his economy.”

Draghi’s blunt pledges, such as saying last month that policy makers will “do what we must,” are being heard by investors. One measure of inflation expectations -- five-year, five-year swaps -- has climbed to about 1.8 percent from a seven-month low of 1.56 percent at the end of September.

Making Waves

Yet the ECB’s goal of inflation just under 2 percent hasn’t been reached since early 2013 and data on Wednesday showed the rate unexpectedly stalled in November at just 0.1 percent. Core inflation slowed. That bolsters the argument for adding stimulus to prevent expectations weakening again.

“Whenever expectations of inflation become more and more negative, we have higher and higher real rates,” Draghi said after the Oct. 22 meeting. “That’s one of the reasons why we consider other non-standard monetary-policy measures.”

Four years into his eight-year term, Draghi has shown he’s comfortable making waves. He burnished his reputation as an aggressive policy maker in 2012 when he committed to do “whatever it takes” to save the euro from the region’s debt crisis. Earlier this year, he overcame divisions within the central bank to deliver quantitative easing.

‘Front Foot’

“It’s clear that Draghi wants to get inflation back to the central bank’s objective as quickly as possible and is worried that emerging-market and geopolitical risks will make this less likely,” said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York.

For Elga Bartsch, co-chief global economist at Morgan Stanley, what’s also new is the desire to set the tone in financial markets without waiting for Yellen’s input. Fed officials will set U.S. monetary policy on Dec. 16.

“My sense is that Mario Draghi wants to be on the front foot on this one,” Bartsch said. “The change is it’s not everyone waiting for the Fed.”

Morgan Stanley reckons that along with stimulus from the Bank of Japan, the ECB’s additional purchases will offset the lack of additional bond-buying from the Fed and Bank of England. The ECB’s assets of 2.7 trillion euros are equivalent to 20 percent of euro-area gross domestic product, and growing. Fed assets total $4.5 trillion, about a quarter of the U.S. economy.

‘Gravitational Force’

The ECB may also effectively dictate moves elsewhere in Europe. As loose monetary policy weakens the euro against currencies such as the Swiss franc, Swedish krona and Danish krone, it risks making those economies’ exporters less competitive -- and so drawing a response from their central banks.

“The further into negative territory ECB rates go, the greater their gravitational force on other central banks,” said Neville Hill, co-chief global economist at Credit Suisse Group AG.

The Fed is likely to be in a minority. Capital Economics Ltd. predicts that of the 20 central banks it monitors, 58 percent will ease between now and the end of 2016, and 30 percent will tighten. The People’s Bank of China, central bank for the world’s second-largest economy, will probably loosen.

Even when the Fed starts to raise rates, it won’t be especially hawkish. Yellen has pledged to be careful as U.S. inflation remains weak. Citigroup Inc. predicts the benchmark rate will rise to 1.5 percent from near zero by the end of 2017. In the past three cycles, it was boosted 200 basis points in the first year alone.

“Global monetary conditions should remain very accommodative in the years ahead,” said Michael Pearce, an economist at Capital Economics.

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