European Economy

Draghi Tiptoes Toward the QE Exit

The ECB president is right to resist German pressure to change course.

"Come back next year."

Photographer: Alex Kraus/Bloomberg

European Central Bank President Mario Draghi knows he'll eventually have to end the central bank's bond-buying program and raise interest rates. But he's rightly determined, no matter how much pressure Germany brings to bear, to keep that day as far in the future as possible -- which makes the rest of this year a non-event for euro zone policy changes.

QuickTake Europe's QE Quandary

And that pressure's growing. With German inflation climbing to 2.2 percent last month, German Finance Minister Wolfgang Schaeuble put the squeeze on Draghi in a speech on Thursday prior to the central bank chief's press conference:

I’m advocating -- with all due restraint because of the independence of the central banks -- a timely entry into the exit. It will be difficult enough, but it must be done.

Draghi, though, said he's not convinced that euro zone inflation passes the four criteria he set as a test before declaring victory in achieving his target: that consumer price gains are durable over the medium-term, are sustainable rather than transient, are robust enough to survive the withdrawal of quantitative easing and applies to the region as a whole:

We see no signs yet of a convincing upward trend in underlying inflation. Headline inflation is likely to remain at levels close to 2 percent in the coming months, largely reflecting movements in the annual rate of change of energy prices. Measures of underlying inflation, however, have remained low and are expected to rise only gradually over the medium term.

Consumer prices have risen recently. Price gains in the euro region as a whole reached 2 percent in February, while in Spain the measure accelerated to 3 percent. Even in Germany, however, the outlook is for inflation to fall back below target, which is why Draghi is correct to resist any premature rise in interest rates that could snuff out the nascent recovery in prices in the euro bloc:

Converging Below Target

Economists see inflation remaining below the ECB's target in the coming quarters

Source: Bloomberg

Figures for Q3 and Q4 2016 and Feb 2017 are outcomes; the remainder are forecasts taken from the Bloomberg ECFC function

The ECB's monetary policy committee had what Draghi called "a cursory discussion about whether to remove the word `lower' from the forward guidance." Instead, it opted to retain the pledge that rates will remain "at present or lower levels." The futures market, though, has erased bets on further rate cuts, although it sees only a modest increase in the benchmark deposit facility rate in a year's time; even then, the level is seen staying below zero for the next three years:

A Gentle Ascent Back to Zero

Market outlook for ECB's deposit facility rate (currently -0.4%)

Source: Bloomberg's MIPR (Market Implied Policy Rates) function

Even though the ECB raised its inflation forecast for this year to 1.7 percent, compared with its December expectation for 1.3 percent, it predicts a drop to 1.6 percent next year and a return to 1.7 percent in 2019.

The ECB is clearly in no rush to match the Federal Reserve in raising borrowing costs. Unless and until inflationary pressures start to build, Draghi is right to resist German calls to call a halt to monetary stimulus in the euro region.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.