Mario Draghi is on his final stretch, and it’s not an easy road to travel.
The European Central Bank (ECB) 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. The ECB will almost certainly 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 2%.
There’s also a strong case for the ECB to restart quantitative easing, which ended last December - indeed, many economists expect Draghi to announce a new round of bond purchases next 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 Lagarde to implement the change after she takes charge in November?
At a hearing at the European Parliament this week, Lagarde promised to act with “agility” to combat dwindling inflation and said a “highly accommodative policy is warranted for a prolonged period.”
As such, the financial markets have a good indication that she’ll follow Draghi’s lead in keeping things very loose. So perhaps it would be wiser to wait for her to thrash out the details of any controversial new asset purchase program with the ECB’s governing council (which includes all of the euro area’s central bankers).
The case for a new round of stimulus is certainly powerful. Inflation stood at 1% in August, well below the central bank’s target. Core inflation, excluding volatile items such as energy, tobacco and food, was even lower at 0.9%. The eurozone – with Germany foremost – is grappling with a major external shock courtesy of the ongoing trade conflict between the US 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 -0.4% and to push out the date for when rates are expected to rise finally. 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 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 will also help weaken the euro to provide some 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 33% cap. Germany has fought hard to keep such limits.
In normal circumstances there would be a strong case for reactivating QE immediately. But with 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 might argue that it’s best for Draghi to act now to let Lagarde find her feet when she starts. But a new president can make their mark quickly. 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 Draghi has said himself, the eurozone requires a stimulus that goes beyond monetary policy. Governments – Berlin in particular – should use extremely low interest rates to put together a coordinated fiscal stimulus and to re-balance economies toward domestic demand. The ECB must do its part too, of course, but it’s Lagarde who will have to own its policies for the next eight years. — Bloomberg
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times. The views expressed here are solely that of the writer.