Draghi Convenes Retreat as ECB Contemplates New HorizonJeff Black and Alessandro Speciale
As Mario Draghi secludes himself with Europe’s top minds in central banking this week he won’t be able to escape one question: What’s next?
After all but promising that he’ll ease monetary policy in June, the European Central Bank president must now manage market expectations as banks from Goldman Sachs Group Inc. to Societe Generale SA speculate whether he’ll go further and deploy large-scale asset purchases in coming months. Draghi late yesterday opened the first ECB Forum, a gathering of policy makers and academics to be held annually in the hills northwest of Lisbon.
What Draghi says in two appearances today and tomorrow may offer clues on how he plans to overcome the stubbornly-low inflation that’s threatening the euro area’s return to economic health. Officials have said they’re working on a package of possible measures for the June policy meeting, including interest-rate cuts and liquidity injections and are holding out the prospect of quantitative easing as a more-powerful option. Draghi is due to speak at 9:00 a.m. local time.
“An important part of the package will be the accompanying words,” said Francesco Papadia, a former director general of market operations at the ECB and now chairman of Prime Collateralized Securities in Frankfurt. “If he says that the council has given a first installment of measures and will be ready to do more if needed, especially when it comes to bringing inflationary expectations more quickly toward 2 percent, this could give more weight to the easing package.”
Draghi is hosting the event in Sintra, Portugal, which the bank is keen to promote as a European answer to the U.S. Federal Reserve’s annual monetary conference in Jackson Hole, Wyoming. He’ll wrap up with closing remarks in tomorrow afternoon.
The ECB president opened the event as results poured in from elections to the European Parliament showing a surge in support for protest parties. Draghi said people want central bankers to provide answers to “thorny questions” of growth and distribution.
“People voting across Europe are clearly disengaged,” Draghi said. “Sustainable growth and jobs are vital to continue European integration, which is, let’s never forget, the best guarantor of peace.”
Nobel Laureate Paul Krugman and Princeton University’s Markus Brunnermeier are among the delegates to address the getaway at Penha Longa, a resort that traces its origins back to a 14th century monastery.
IMF Managing Director Christine Lagarde delivered the opening address, and warned policy makers that a new range of instruments, known as macroprudential tools, to foster financial stability aren’t proven.
ECB Executive Board members Vitor Constancio, Peter Praet and Benoit Coeure will chair panel discussions today and tomorrow, which will include examinations of the role of such instruments in the central bank repertoire.
The biggest question in Sintra will be whether Draghi elaborates on his assertion, made on May 8, that the Governing Council is “dissatisfied” with the inflation outlook and “comfortable” with action in June. Inflation has been below 1 percent since October, less than half the ECB’s goal, and economies from Italy to the Netherlands contracted in the first quarter.
So far, investors have taken him at his word. The overnight rate that banks expect to charge each other a year from now, as measured by Eonia forward contracts linked to ECB meetings, had dropped to 0.05 percent by May 23 from 0.14 percent on May 7, a day before the last rate decision. The euro fell to a three-month low of just above $1.36, after climbing as high as $1.3993 on May 8.
Ninety percent of economists in the Bloomberg Monthly Survey predict the European Central Bank president will ease policy in June. Most forecast a simultaneous cut in the benchmark rate, now at 0.25 percent, and the deposit rate, which is at zero. That would make the ECB the first major central bank to charge for holdings lenders’ excess cash overnight. Denmark ended its experiment with negative rates last month.
A much lower likelihood is given to asset purchases, which were seen by just 8 percent of the economists in the survey. While Draghi has said that is a policy option, officials have so far stopped short of the quantitative easing programs conducted by the Fed, Bank of England and Bank of Japan.
The ECB is currently considering a combination of measures, Praet and fellow Executive Board member Yves Mersch said this month. A package could include a negative deposit rate and a liquidity injection tied to provisions that banks lend the money on to the real economy, Praet said.
ECB Governing Council member Jens Weidmann, the head of Germany’s Bundesbank, said last week that he hasn’t yet agreed on any specific measures and the decision will depend on inflation projections rather than the current rate.
Draghi said last month that a worsening of the medium-term inflation outlook would justify broad-based asset purchases. The ECB’s Survey of Professional Forecasters published on May 15 showed a downgrade in inflation projections and the central bank’s own staff forecasts, which policy makers will see at their June 5 meeting, may do the same.
Even so, that won’t be enough to trigger quantitative easing just yet, according to Michala Marcussen, global head of economics at Societe Generale in London.
“We believe that a more significant deterioration of the growth and inflation outlook is required for the ECB to adopt a large-scale, broad-based asset purchase program in June,” she said. “We also expect the ECB to keep the door open for more should inflation continue to surprise to the downside.”
While investors are focused on what the ECB will do on June 5, they’ll also keep looking for clues as to longer-term plans, said Huw Pill, chief European economist at Goldman Sachs in London.
“Market participants will focus on whether the new package is presented as another step along an inexorable path toward the introduction of large-scale asset purchases later in the year,” Pill said. “Draghi’s tone and body language in making the announcement are likely to weigh heavily on market sentiment.”