Draghi Aggression Shows Pledges Backed by Rate Surprise

Mario Draghi is showing that when he pledges action, he means it.

With yesterday’s surprise rate cut, the European Central Bank president delivered on an Oct. 2 promise to act if its price-stability mandate is threatened. The move comes more than a year after Draghi turned the tables on Europe’s sovereign debt crisis by saying he’d do “whatever it takes” to save the euro and presenting an unlimited bond-buying program. His policy announcements show a pattern that started two years ago with an unexpected rate reduction at his first meeting in charge.

The 66-year-old Italian is turning the ECB into a more aggressive institution less concerned with finding consensus among its 23-member Governing Council than with deploying stimulus when it’s needed. The bond-purchase plan, the most-radical in the ECB’s history, was pushed through against the wishes of the Bundesbank. Jens Weidmann, Germany’s representative on the council, also opposed yesterday’s move, according to two officials familiar with the situation.

“The ECB is more flexible than many give them credit for, and under Draghi it’s even more flexible,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “The ECB is clearly now embarking on a campaign against uncomfortably low inflation. Further moves could follow.”

‘Impossible Tasks’

The euro was set for its biggest two-week decline in more than a year after the rate cut and France’s downgrade to AA at Standard & Poor’s. The common currency was at $1.3419 as of 12:01 p.m. Frankfurt time, down 2.8 percent over two weeks.

Euro-area inflation slowed to 0.7 percent in October, less than half the ECB’s target level of just under 2 percent. While that prompted some economists to predict that a rate cut was on its way, more said it would happen in December than this month. Just three of 70 economists surveyed by Bloomberg News forecast the reduction.

“The very fact that Draghi today demonstrated again a capacity to act fast and energetically strengthens our core conviction for Europe,” said Holger Schmieding, chief economist at Berenberg Bank in London. “Draghi will do whatever it takes to get the euro zone through the euro crisis.”

While Draghi’s predecessor Jean-Claude Trichet won plaudits for the ECB’s swift response to the early days of the financial crisis when it injected liquidity into markets in August 2007, it was later criticized for not cutting interest rates as deep as other central banks and for raising them twice before the turmoil was calmed.

Reduced Effectiveness

At Trichet’s farewell gala in October 2011, Draghi said “friends tell me that I rarely shy away from impossible tasks.” In July last year he said that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” following it in September with the Outright Monetary Transactions program. Last month he said the ECB is “ready to act according to need” to boost liquidity in the banking system.

“I have a huge amount of respect for the Draghi regime,” said Kit Juckes, global strategist at Societe Generale SA in London. “He is incredibly imaginative and innovative, even if he isn’t armed with big-enough weapons.”

Lack of weaponry may be Draghi’s biggest obstacle now. He told reporters after yesterday’s rate cut that “the effectiveness of standard measures of monetary policy is greatly reduced as you go down to the zero lower bound.”

By cutting the benchmark rate to a record low of 0.25 percent, the ECB president has just one more conventional quarter-point cut in the bag before reaching zero.

‘More Pragmatic’

The deposit rate, the rate for commercial lenders who park excess cash at the central bank, was left at zero. While Draghi again floated the prospect of a negative rate, policy makers have said that its effects can’t be adequately predicted.

On the one hand, the move could encourage banks to lend money to companies and households instead of keeping it at the ECB. However, it could also hamper their profitability as they may not be able follow the ECB into negative terrain. As a result, the spread between the rate banks charge for loans and the amount they pay depositors gets compressed.

“The ECB under Mario Draghi has become much more pragmatic and pro-active than under any of his predecessors,” said Carsten Brzeski, senior economist at ING Groep NV in Brussels. At the same time, “further deflationary pressure will be hard to tackle by monetary policy.”

That increases the pressure for unconventional measures such as quantitative easing that face even more resistance from the Bundesbank, the central bank for Europe’s largest economy. The ECB is barred by European Union treaties from financing state debt, making large-scale purchases of government bonds open to a legal challenge.

Draghi “may be a bit more American, to some extent more pragmatic and market oriented,” said Frederik Ducrozet, senior euro-area economist at Credit Agricole CIB in Paris. “The Germans have likely been isolated. This doesn’t mean they don’t care what the Bundesbank thinks, but it no longer has a veto.”

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