Draghi Builds United Front for New Push Against DeflationJana Randow
Mario Draghi is building a united front for the European Central Bank’s next big push should the threat of deflation turn into reality.
With consumer-price gains at just a quarter of the ECB president’s goal, officials are rallying behind even the most controversial tool available -- quantitative easing. The endorsement by Bundesbank President Jens Weidmann of bond purchases and a negative deposit rate, even if their immediate use is unlikely, shows policy makers are determined to take whatever steps are needed to prevent Japan-style deflation.
As ECB officials gather in Frankfurt today for their monthly interest-rate decision, Draghi must judge whether the factors curbing prices are temporary or pose such a fundamental threat to the recovery in the 18-nation euro area that they require immediate action. Policy makers refrained from cutting rates in March, even as ECB forecasts showed inflation staying below target through 2016, and economists surveyed by Bloomberg say they’ll stay on hold again this month.
“Many would argue that the inflation outlook in particular has been bad enough for a long time already to justify more ECB action,” said Greg Fuzesi, an economist at JPMorgan Chase & Co. in London, who forecasts rates will stay unchanged. “We view the recent comments by Weidmann on QE and a negative deposit rate as helpful as they allow Draghi to threaten action more credibly.”
The ECB will announce its interest-rate decision at 1:45 p.m. in Frankfurt and Draghi will hold a press conference 45 minutes later. All but three of 57 economists in a Bloomberg News survey predict borrowing costs will stay unchanged at 0.25 percent. Credit Agricole SA and Danske Bank A/S forecast a cut to 0.15 percent, and Goldman Sachs Group Inc. sees a reduction to 0.1 percent.
A small rate cut “will be largely cosmetic from a macroeconomic perspective, but help to avoid giving the impression of an indifference to low inflation outcomes and a lack of concrete action following much dovish rhetoric,” said Sebastian Graves, an economist at Goldman Sachs in London. “More aggressive unconventional measures remain distant.”
Even so, Weidmann’s stance shows a consensus that hasn’t always been easy to reach. The Bundesbank head criticized Draghi’s September 2012 pledge to buy the bonds of stressed countries if their governments commit to reforms, and was among a minority of Governing Council members who opposed a surprise rate cut in November last year.
The strength of the new consensus probably won’t be tested this month. Instead, Draghi is likely to reiterate that inflation will gradually rise and that short-term price weakness can be explained by weaker food and energy costs and seasonal distortions such as the timing of the Easter holidays.
Euro-area inflation slowed to 0.5 percent in March, the lowest level since November 2009. Spain, the region’s fourth-largest economy, saw annual prices decline for the first time since 2009.
Christine Lagarde, the International Monetary Fund’s managing director, said in Washington yesterday that the euro area needs more monetary easing, including unconventional measures. She said the region must counter the risk of so-called “lowflation,” or a prolonged period of ultra-low inflation.
ECB Vice President Vitor Constancio said on April 1 in Athens that he expects “the low figure in March will be corrected to a high figure in April” and the central bank sees no prospect of deflation. Policy makers define their mandate for stable prices as keeping inflation of just under 2 percent. ECB staff projections show the rate rising to 1.5 percent in 2016 from 1 percent this year.
“There is a compelling case for the ECB to provide additional monetary-policy accommodation,” said Ken Wattret, chief euro-area economist at BNP Paribas SA in London. “But now, with the Easter effect on inflation in March difficult to gauge and with little conventional policy ammunition left, the preference may be to wait for more information.”
Policy makers may use that time to discuss the operational details of their options. As well as QE and a negative deposit rate, the ECB could offer new long-term loans to banks, bolster the market for asset-backed securities, or stop the absorption of liquidity from bond purchases under its now-defunct Securities Markets Program.
Since Draghi said in March that the euro area was meeting the ECB’s baseline scenario of a gradual recovery, he’s been able to gather data to support his case. Economic confidence is the strongest since July 2011, and lending to companies and households rose month-on-month in February for the first time since July 2012.
A gauge of manufacturing and services activity by Markit Economics Ltd. remained close to the highest level in almost three years in March. The ECB predicts gross domestic product will expand 1.2 percent this year, accelerating to 1.8 percent in 2016. The currency bloc’s economy grew 0.2 percent in the fourth quarter of last year, less than an initial estimate, data from the European Union’s statistics office showed yesterday.
International investors are returning to the region, including to nations that received bailouts in the depths of the crisis. The premium investors demand to hold Spanish 10-year bonds over German debt was less than 1.7 percentage points yesterday, compared with a euro-era high of more than 6 percentage points in July 2012. U.S. exchange-traded funds show net inflows of $106 million in Greece this year, an increase of 80 percent.
The improved outlook has contributed to a stronger euro, to the extent that it threatens to curb inflation and hurt the competitiveness of exporters in the region. The single currency has gained more than 7 percent against the dollar in the past 12 months and while the ECB doesn’t have a policy target for the exchange rate, Draghi said on March 25 that he’s watching the level “with attention.”
The ECB president has repeatedly tried to counter unwarranted optimism. At the March 6 meeting, he strengthened his guidance by citing slack in the economy as a reason why official rates will stay at or below current levels even after the economy shows signs of improvement.
The output gap was employed as a guidance tool only three weeks earlier by Bank of England Governor Mark Carney. Federal Reserve Chair Janet Yellen said on March 31 that “considerable slack” remains in the U.S. economy as she argued that the country will need stimulus for some time.
While the ECB hasn’t released its own measurement of spare capacity, there are multiple other estimates. The IMF predicts euro-area GDP in 2014 will be 2.5 percent below its potential, and the shortfall will gradually narrow to 0.4 percent in 2018. The European Commission sees the gap at 2.4 percent this year, shrinking to 1.3 percent in 2015.
“Slack will continue to curb inflationary pressures,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “This will keep the possibility of further monetary policy easing very much alive.”
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