Draghi’s Deflation Warning and the QE Obstacle CourseJana Randow
Between Mario Draghi and quantitative easing lies an obstacle course.
The European Central Bank president’s signal that he’s considering large-scale bond purchases raises the question of how to surmount hurdles from political and legal challenges to conflicts with measures announced just three months ago. For policy makers meeting in Frankfurt this week, those factors add to an already complicated debate on how to shore up a euro-area economy that’s edging closer to deflation.
Banks including Nomura International Plc and UniCredit SpA say the odds of QE have increased since Draghi warned at last month’s high-profile central banking conference in Jackson Hole, Wyoming, that the outlook for prices is worsening. Few see such drastic action right away.
“The ECB probably thinks further stimulus is premature at this stage,” said Marco Valli, chief euro-area economist at UniCredit in Milan. “Draghi enhanced his rhetoric to show the market he’s paying great attention to inflation expectations. Chances for full-blown QE have gone up, but it’s a last-resort measure and the bar is still high.”
The ECB will keep interest rates unchanged at record lows when the Governing Council meets on Sept. 4, according to 50 of 55 estimates in a Bloomberg News survey. Five economists say the key rate will be cut by 10 basis points to 0.05 percent and the deposit rate reduced by the same amount to minus 0.2 percent.
When Draghi spoke on Aug. 22 at the Federal Reserve Bank of Kansas City’s symposium, a forum at which U.S. monetary policy has in the past been announced, he said the ECB’s preferred gauge of inflation expectations has fallen. His remarks mesh with previous comments that a worsening of the outlook for consumer-price growth would warrant broad-based asset purchases.
His words were given more weight when euro-area data showed inflation slowed to 0.3 percent in August, the weakest since 2009 and a fraction of the central bank’s goal of just under 2 percent. July unemployment held near a record at 11.5 percent. A purchasing managers’ index today showed manufacturing slowed more than initially estimated this month.
ECB Executive Board member Benoit Coeure said the central bank “is ready to further adjust the direction of its monetary policy if needed,” according to comments published in Greece’s Ta Nea on Aug. 30. French Prime Minister Manuel Valls said in a speech the following day that while the ECB has sent a strong signal so far, “one will have to go even further.”
Draghi will meet with French President Francois Hollande today to discuss the state of the euro-area economy, an ECB spokeswoman said in an e-mailed statement.
Equities and bonds have rallied on speculation QE is coming. Even so, economists have warned against rushing in. Nick Matthews, senior economist at Nomura, says there’s only a 30 percent chance of QE in the euro area this year, up from 25 percent before the speech. For now, he predicts the central bank will cut interest rates this week and announce a program to buy asset-backed securities by December.
“QE is still not deemed necessary, or appropriate,” he said. “I’m still not convinced they want to get there.”
Policy makers already have plenty on their plate. One of the most-novel initiatives announced in June, funding for banks linked to real-economy loans, hasn’t even started. The first allotment in the targeted longer-term refinancing operations, or TLTROs, will be on Sept. 18 and the program won’t be fully implemented until 2016.
The ABS plan Draghi promised is also pending. The ECB has hired BlackRock Inc., the world’s biggest money manager, to advise on a program with the twin aims of reviving the shrinking European securitization market and providing another liquidity tool. ABS purchases could be part of a larger QE program.
“Before having new weaponry in place, they have to apply what is already decided,” former ECB President Jean-Claude Trichet said in an interview with CNBC last week. “We have two new decisions in the pipe that will be implemented soon and that shouldn’t be underestimated by the markets.”
Michael Schubert, an economist at Commerzbank AG in Frankfurt, said policy makers must consider the extent to which QE and existing stimulus measures would work against each other.
“QE risks reducing the incentive to borrow under the TLTRO program if it creates a lot of liquidity, and the negative deposit rate counteracts QE because banks would be charged for the liquidity,” he said. “The ECB will find itself in a situation where individual programs increasingly contradict each other.”
This week’s decision on monetary policy will be guided by new ECB economic forecasts that Governing Council member Ewald Nowotny has signaled will probably be revised down. In June, the central bank predicted average 2014 inflation of 0.7 percent, a level surpassed only once this year and more than twice as high as the current rate. It predicted gross domestic product would expand 1 percent this year. GDP stagnated last quarter after rising 0.2 percent in the first three months.
“Draghi has to deliver some kind of next step now because saying ‘we’re no longer credible and inflation expectations have dislodged’ and not doing anything about it doesn’t work,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “I have some doubts whether they’ll get consensus for QE-style government-bond purchases, but an ABS-purchase program would give them something to play with.”
Bundesbank President Jens Weidmann has frequently warned of the dangers of QE, suggesting the German central-bank head would take some convincing of the merits of a plan.
One concern is that European Union laws prohibit central-bank financing of governments. OMT, Draghi’s as-yet untapped bond-purchase program announced in 2012, was challenged in the German constitutional court where Weidmann argued against it. OMT is now being reviewed by the EU’s highest tribunal.
Another hurdle is the logistics of what to buy in an area where bond issuance is in the hands of 18 national governments.
“There are enormous political, legal and moral-hazard constraints,” said James Nixon, an economist at Oxford Economics Ltd. in London. “The euro area isn’t a single, sovereign nation state. That’s a fundamental obstacle.”
Politicians in Germany, the region’s biggest economy, have repeatedly expressed concern that ultra-loose monetary policy could inflate asset bubbles. Finance Minister Wolfgang Schaeuble said on Bloomberg Television last week that “liquidity in markets is not too low, it’s even too high -- therefore I think monetary policy has come to the end of its instruments.”
While the ECB is by law independent from governments, that’s an argument officials may also discuss. Buying public debt would push investors into riskier private assets and may blow “ever greater bubbles,” according to Elwin de Groot, senior euro-area strategist at Rabobank in Utrecht, Netherlands.
“As long as alternative measures aren’t fully exhausted, the ECB has the means to dodge the decision,” he said. “Having said this, being overly dogmatic about fundamental issues hasn’t really paid off in the past couple of years. So when push comes to shove, we would expect the ECB to be dragged into QE.”