Sunday 27 May 2018

Draghi reaches for bazooka as markets turn - but a question remains: can the ECB really do 'whatever it takes'?

The ECB president Mario Draghi may have eased market worries last week when he set the scene for a new round of quantitative easing - but can Super Mario deliver? Or will he disappoint again, ask Paul Gordon and Jeff Black

‘We have the determination, and the willingness and the capacity of the Governing Council, to act and deploy these instruments,’ ECB president Mario Draghi told the World Economic Forum. Photo: Ruben Sprich/Reuters
‘We have the determination, and the willingness and the capacity of the Governing Council, to act and deploy these instruments,’ ECB president Mario Draghi told the World Economic Forum. Photo: Ruben Sprich/Reuters

Paul Gordon and Jeff Black

A day after kicking off yet another European Central Bank stimulus review, Mario Draghi used Davos as a platform to convince investors he'll do what's needed to reignite consumer prices.

"We've plenty of instruments," the ECB president said on Friday at the World Economic Forum in Switzerland. "We have the determination, and the willingness and the capacity of the Governing Council, to act and deploy these instruments."

The comments reflect the ECB's agreement on Thursday to re-examine its strategy of a €1.5 trillion-bond-purchase plan and negative interest rates. Over the seven weeks until the March 10 gathering, officials are likely to try to guide investors to avoid a repeat of last month's meeting, when fresh stimulus fell short of predictions stoked at the previous decision.

"It's a bit like Groundhog Day," said Carsten Brzeski, chief economist at ING-DIBA in Frankfurt, reminiscing about the 1993 Bill Murray comedy. "The only question is, will he fulfil the dreams of markets this time around, or will he disappoint again?"

ECB Executive Board member Benoit Coeure, who is responsible for the Central Bank's market operations and was a key architect of quantitative easing, reiterated the pledge on a separate panel at Davos. "We are very committed" to returning inflation to the goal of just under 2pc, he said.

Draghi's challenge has become tougher as China's economic slowdown increasingly drags on global trade and disrupts markets. The problems in China are prompting central bankers around the world to assess what tools they have if there is a renewed global downturn.

Last week China reported that its gross domestic product grew by 6.8pc during 2015 - the slowest rate since 1990. That has helped drive markets to one of their worst starts to a year in decades. US and most European markets have fallen at least 10pc from their highs and into a "correction", while the UK FTSE 100 briefly fell 20pc and into a Bear market.

On Friday, European markets recorded their best end to a week since 2011, rising more than 3pc on Friday alone. That level of volatility, however, is every bit as concerning to bankers and traders as the falls that have been recorded in the year to date.

Away from equity markets, oil has continued to slump despite a brief rebound on Friday while bond yields have plunged as traders head to safer securities.

The tensions in international markets have puzzled some policy-makers because the indicators around the global economy in general have remained strong so far. US unemployment remains low and it hit a 10-year low in the UK, GDP growth outside of China has remained strong in the US and has been solid, if relatively anaemic in Europe.

Euro-area inflation was 0.2pc last month and hasn't been near the goal since early 2013.

The ECB president said the three current drivers of the euro-area recovery are monetary policy, a fiscal stance that is "broadly neutral if not slightly expansionary" and lower energy prices that support disposable income. Yet policy makers are worried over the risk that ultra-low inflation will persist, undermining the economic revival.

"There's less reason to be optimistic" over the outlook for consumer prices, he said. "It's mostly because of the collapse in oil prices but also because of the revision, the downward revision" of economic growth in emerging markets.

That view was backed by the ECB's quarterly Survey of Professional Forecasters, published on Friday. Analysts cut their euro-area inflation outlook for this year and next, and said the rate would average 1.6pc in 2018. That's a level the Frankfurt-based ECB less than two months ago projected would be reached by 2017. Too-low inflation risks damping wage increases and aggregate demand.

"There is the risk that the decline of the oil price also has an impact on core inflation via second-round effects, for instance due to lower transport costs," Governing Council member Ewald Nowotny said in Vienna on Friday.

On further measures, he said that "over the course of last year, we went into territories that we would have seen as unthinkable, so it's very difficult to set limits anywhere these days".

An economic gauge showed private-sector growth in the 19-nation currency bloc slowed to the weakest in almost a year amid volatility in financial markets.

At the same time, the Purchasing Managers' Index for manufacturing and services still points to growth of as much as 0.4pc at the start of the year, Markit Economics said.

Draghi noted that euro-area monetary policy will diverge from the US for a while, bolstering the ECB's accommodative stance. The Federal Reserve's decision in December to start raising its own rates was "appropriate" given the improving US economy and was "flawlessly executed", he said.

On Thursday, after the central bank left interest rates at record lows, he noted that new ECB macroeconomic projections would be published after the March meeting, including the first prognosis for 2018. Any deterioration in the outlook could provide the justification for more action.

Draghi said the Governing Council would "absolutely reject" any suggestion that it'll do less than what's necessary and that "we are not surrendering" to the global pressures. Economists at JPMorgan Chase and Royal Bank of Scotland changed their forecasts for easing to March from June.

Barclays Chief European Economist Philippe Gudin wrote in a note that "the new package that we predicted for June could be presented in March", depending on developments. Draghi also said on Thursday that measures announced at the December 3 meeting were "entirely appropriate based on the circumstances prevailing at that time" but that conditions had since changed.

Still, he didn't exclude that officials had a role in an outcome that sent bond yields and the euro surging.

"Communication is a two-way affair," he said. "It's very hard to put the blame of some disappointment on one side only."

He said the Governing Council did not want to discuss any specific instrument and that the ECB's technical committees would study options. However, the Central Bank wants to be "absolutely confident that there are no technical limits to the size of its deployment".

Any limit on the size of the ECB's "deployment" capacity could turn Draghi's "do whatever it takes" statement from 2012 into empty words. Much like former US Treasury Secretary Henry Paulsen's line in 2008 about having a bazooka but being able to keep it in your pocket, Draghi's words only have power if he never has to back them up to the hilt. If there are restrictions on how much cash the European Central Bank can deploy to buy bonds, then it would suggest other possibilities.

That raises the question of whether the ECB is willing to go down the same path as the Bank of Japan (BOJ) by adding new asset classes to its QE program. As long ago as 2002, the BOJ was buying equities. Under the current program, the ECB purchases government and agency debt, covered bonds and asset-backed securities, and policy makers agreed last month to extend it to regional debt of euro-area member states.

"This is classic Draghi-speak," said Anatoli Annenkov, senior economist at Societe Generale in London. "He's reacting to the changed circumstances, but we still need to wait for the new forecasts and the council to come together. I'm not sure that means more or less action, and the markets will also need to learn from the experience in December."


Business Newsletter

Read the leading stories from the world of Business.

Also in Business