Europe likely to need more QE once Lagarde takes the reins at ECB
Mario Draghi is on his final stretch, and it's not an easy road to travel.
The European Central Bank president will chair a decisive governing council meeting next week, barely a month and a half before he hands over the reins to Christine Lagarde, the current chief of the International Monetary Fund.
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The ECB almost certainly will announce a hefty stimulus package on Thursday, including rate cuts, to try to lift dwindling inflation back toward the central bank's target of just below 2pc.
There's also a strong case for the ECB to restart quantitative easing (QE), which ended in December. Indeed, many economists expect Mr Draghi to announce a new round of bond purchases this week.
But given the political delicacy around the return of QE, with the French, German and Dutch central bank governors all voicing scepticism, would it not be better to wait for Ms Lagarde to introduce the change after she takes charge in November? At the European Parliament last week, Ms Lagarde promised to act with "agility" to combat dwindling inflation. She said a "highly accommodative policy is warranted for a prolonged period".
As such, the financial markets have a good indication that she'll follow Mr Draghi's lead in keeping things loose. So perhaps it would be wiser to wait for her to thrash out the details of any controversial new asset purchase programme with the eurozone's central bankers on the ECB's governing council.
The case for a new round of stimulus is certainly powerful. Inflation stood at 1pc in August, well below the central bank's target. Core inflation, excluding volatile items such as energy, tobacco and food, was even lower at 0.9pc.
The eurozone, in particular Germany, is grappling with a major external shock courtesy of the ongoing trade conflict between the United States and China. The ECB is expected to revise its inflation and growth forecasts downward on Thursday. The governing council needs to act forcefully to stop the deceleration of prices.
A logical first step would be to cut the deposit rate further into negative territory from its current -0.4pc and to push out the date for when rates are expected finally to rise, currently pitched at the second half of 2020.
The council should examine whether there's a way to mitigate any damaging effects on the profitability of commercial banks from negative rates, but this ought not to be a priority. A lower deposit rate should encourage lenders to do something more useful with their money than park it with the ECB. It also will help weaken the euro to provide assistance to exporters.
The question of resuming net asset purchases is thornier. This idea is divisive for council members and would need technical adjustments to the previous QE scheme.
For example, because of the ECB's already vast holdings of sovereign debt, it would have to raise the proportion of any nation's government bonds that it can own above the current 33pc cap. Germany has fought hard to keep such limits, but some analysts argue that this key rule should be eased before Ms Lagarde's arrival.
"If QE is restarted, which we expect, we think it is important that the ECB also lifts the current 33pc issuer limit to send the signal that additional purchases could carry on beyond the initial six-to-nine month horizon," Marchel Alexandrovich, the senior European economist at Jefferies, argued in a recent note to investors.
"By not addressing the issuer limit now, it would unnecessarily delay the discussion into next year and raise some doubt as to whether it could be increased at all.
"Raising the limit to 40pc would eliminate any doubt that QE... could proceed for perhaps another 18 months. This would not only send a strong message that the ECB has 'not run out of ammunition' - something heard far too often - but also make Ms Lagarde's task considerably easier."
In normal circumstances there would be a strong case for reactivating QE immediately. But with Mr Draghi on his way out, his successor should be involved in the deliberations of what the next steps should be. Any moves that split the board would be best taken when the new president is around, to appear more credible.
Some argue it's best for Mr Draghi to act now to let Ms Lagarde find her feet when she starts. But the new president can make her mark quickly. Mr Draghi shocked investors by cutting rates at his first meeting in November 2011, establishing his reputation as an effective decision-maker.
As I've argued before, and as Mr Draghi has said himself, the eurozone requires a stimulus that goes beyond monetary policy.
Governments, particularly in Germany, should use extremely low interest rates to mount a co-ordinated fiscal stimulus and to rebalance economies toward domestic demand.
The ECB must do its part too, of course, but it's Ms Lagarde who will have to own its policies for the next eight years.