Draghi Signals ECB Action as Inflation Expectations Slide

Mario Draghi said inflation expectations have deteriorated across the euro area and signaled policy makers are ready to add fresh monetary stimulus.

In his strongest indication yet that officials aren’t finished with measures to stave off a Japan-style stagnation, the European Central Bank president told his international counterparts in Jackson Hole, Wyoming, yesterday that investor bets on euro-area inflation have “exhibited significant declines at all horizons” in August.

“The Governing Council will acknowledge these developments and within its mandate will use all the available instruments needed to ensure price stability over the medium term,” he said in ad-libbed remarks during a speech at the Federal Reserve Bank of Kansas City’s annual economic symposium.

Draghi has previously said that any worsening of the medium-term inflation outlook would provide a reason for the ECB to carry out broad-based asset purchases, or quantitative easing. His comments come days before data that is predicted to show euro-area inflation slowed to 0.3 percent this month, a fraction of the ECB’s goal and the weakest since October 2009.

Inflation Expectations

The 18-nation economy stalled in the second quarter and unemployment remains near a record high. Draghi’s concern is that the malaise prompts investors, consumers and companies to pull back spending in anticipation of even weaker inflation, tipping Europe into a deflationary spiral that would be hard to reverse.

He cited the ECB’s preferred gauge for inflation expectations, which fell below 2 percent this month. The last time the 5-year, 5-year inflation swap rate crossed that level, which matches the central bank’s price-stability threshold, was in October 2011, according to data compiled by Bloomberg.

The stalled economy and slowing price gains also come against the backdrop of escalating sanctions against Russia because of its support of separatists in Ukraine, raising the risk to regional trade. Citigroup Inc. economists said yesterday they predict a 1 trillion euro ($1.3 trillion) package of broad-based asset purchases will be unveiled in December.

“The odds of such a program are rising, although whether or not it will happen is still very much uncertain,” Roberto Perli, a partner at Washington-based Cornerstone Macro LP, said after Draghi spoke. “Still, the odds of QE are going up and that is probably more important for the markets than the exact date when QE might begin.”

Existing Stimulus

The ECB’s economic outlook increasingly contrasts with that of the U.S. central bank. Fed Chair Janet Yellen told the Jackson Hole conference that the U.S. labor market has made “considerable progress,” though too many Americans are still out of work. Fed officials are slowing monetary stimulus and debating when to exit from ultra-loose policy.

Draghi made no mention of quantitative easing in his speech, instead highlighting steps the ECB is already taking to bolster the economy. The central bank cut interest rates to record lows in June, and will next month start a round of cheap funding for banks linked to loans to the real economy. It is also “fast moving forward” with a program for buying asset-backed securities, and the euro area should benefit from a weaker currency, he said. The euro slid to an 11-month low against the dollar yesterday.

Policy Debate

He said that while he is “confident” that the package of measures will work, “we stand ready to adjust our policy stance further.” He also warned that there is a “real risk” that monetary policy loses some effectiveness.

The ECB’s Governing Council next meets to set monetary policy on Sept. 4 in Frankfurt. It has so far avoided QE amid political and logistical concerns over how such a program would be carried out.

The speech “prepares the ground for a debate that may result in more action,” said Greg Fuzesi, an economist at JPMorgan Chase & Co. in London. It “is not necessarily inconsistent with a central bank that remains focused on implementing the measures it announced in June and, if needed, doing more by enhancing those measures, rather than going straight to sovereign QE. But it will be crucial to see both how the data evolve in the coming weeks and how policy makers more broadly respond to Draghi’s speech.”

Fiscal Push

Draghi intensified pressure on European governments to play their part, saying “it would be helpful” if those with room to ease fiscal policy did so.

“We need action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies,” he said. “We should not forget that the stakes for our monetary union are high.”

He proposed four areas in which fiscal policy could be improved: better use of flexibility within existing European Union rules; lower taxes; stronger fiscal coordination between governments; and EU action to ensure a large public investment program.

Countries including France and Italy have argued for more flexibility with their budgets, and French Finance Minister Michel Sapin said this month that his nation will exceed a deficit target agreed upon less than four months ago with the European Commission. Germany has said governments should stick to the rules on fiscal goals.

Draghi said the ECB can’t do everything alone, and that fiscal boosts can only buy time.

“No amount of fiscal or monetary accommodation, however, can compensate for the necessary structural reforms in the euro area,” Draghi said. These reforms “can no longer be delayed.”

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