Six Years After ECB Disaster Draghi Plots a Middle Ground

  • Premature tightening six years ago was followed by recession
  • Calls to start discussion on QE future are becoming louder

BMO Global's Bell Says European Economy Is Looking Better

As Mario Draghi faces increasing pressure to map out a path toward the end of European Central Bank stimulus, he might want to respond with a history lesson.

For weeks in the run-up to Thursday’s Governing Council meeting, ECB officials have been publicly debating when they might start to wind down their asset purchases and raise interest rates. Yet the institution’s president is determined not to repeat an error made six years ago this month, when his predecessor Jean-Claude Trichet started tightening policy only to see the region slide back into recession.

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On the surface, the euro-area economy is looking robust after four years of growth, with unemployment declining and inflation close to the ECB’s goal. Draghi, who reversed Trichet’s rate increases in his first two months in office, may choose to reiterate that the current recovery is still highly dependent on monetary support as underlying consumer-price growth remains weak and political risks are still elevated.

“Draghi’s 2011 experience probably taught him a lesson from day one: better to tighten later than sooner,” said Maxime Sbaihi, an economist at Bloomberg Intelligence in London. “The experience probably reinforced his dovish stance, and is now helping him to err on the side of caution and patience.”

Economists surveyed by Bloomberg predict the central bank will keep interest rates unchanged and reiterate that its monthly bond-buying program will run until at least December at an already reduced pace of 60 billion euros ($65 billion). The Governing Council’s policy decision will be announced at 1:45 p.m. Frankfurt time and Draghi will hold a press conference 45 minutes later.

Amid a rumbling discussion over the future of ECB’s stimulus, some central banks are signaling their exit from unprecedented monetary easing remains far away. The Bank of Japan kept its stimulus policies unchanged on Thursday while lowering its inflation forecast. Sweden’s Riksbank unexpectedly extended its two-year bond buying program into the second half of the year as policy makers opted to take no chances on inflation backsliding.

Clues that the ECB’s stance may soon need to be reviewed are coming even from within the institution. Executive Board member Benoit Coeure, Draghi’s man in charge of monetary-policy implementation, argued last week that he views risks to the economic outlook as “by and large balanced” and no longer tilted to the downside. 

Backing his view, a report on Thursday showed euro-area economic confidence jumped to the highest level in almost a decade in April. Managers grew more upbeat about the current level of order books and a pick-up in consumer confidence was fueled by greater optimism on jobs, the economy and household finances.

Yet risks remain, especially politically. Anti-euro Marine Le Pen is predicted to garner about 40 percent of support in the second round of France’s presidential elections on May 7 -- not enough to win against centrist Emmanuel Macron but sufficient to cause nervousness among investors for a few more weeks. Italian politics has been in limbo since former Prime Minister Matteo Renzi lost a referendum in December and quit.

Draghi, who was a member of the Governing Council when it unanimously decided to raise rates in 2011, and ECB chief economist Peter Praet have tried to shut down a debate about an exit. The discussion flared up in earnest at the start of the year when inflation in the 19-nation region -- driven by energy and food prices -- approached the central bank’s goal of just-below 2 percent. 

“I do not see cause to deviate from the indications we have been consistently providing,” the ECB president said on April 6. “We have not yet seen sufficient evidence to materially alter our assessment of the inflation outlook -- which remains conditional on a very substantial degree of monetary accommodation.”

Since the ECB lifted its growth and inflation outlook for 2017 and 2018 in March, economic data have demonstrated increasing resilience. Momentum in the private sector accelerated to its fastest pace in six years in April, with France outpacing Germany in a sign that the recovery is broadening. Inflation data due on Friday are forecast to show core price growth accelerated to 1 percent for the first time in just over a year.

Bundesbank President Jens Weidmann has suggested that a “less expansive monetary policy” may be sufficient in light of the strengthening recovery, and argued that a debate about policy normalization was “legitimate.”

Most respondents in Bloomberg’s April 18-20 survey said the ECB will revise its forward guidance as early as June, six months sooner than in the previous poll. The Governing Council currently pledges to keep interest rates at present or lower levels well past the end of quantitative easing.

“Draghi and Praet are trying to avoid making mission-almost-accomplished statements,” said Richard Barwell, an economist at BNP Paribas Investment Partners in London. “There are others who are sufficiently uncomfortable with unconventional monetary stimulus and the pace of reform in the periphery to be willing to pull back even though the likely outcome is inflation consistently undershooting the target seriously.”

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