Draghi reloads the bazooka

The Malta Business Weekly - - LEADER / NEWS -

When Mario Draghi an­nounced the Euro­pean Cen­tral Bank’s land­mark €1.1tn as­set pur­chase plan in Jan­uary, it was in­tended to counter the eu­ro­zone’s in­ter­nal weak­nesses and de­sign flaws in the wake of a debt cri­sis which nearly tore the re­gion apart.

Now the ECB pres­i­dent is hint­ing at yet more stim­u­lus, the threats fac­ing the re­gion are of a dif­fer­ent na­ture to those wit­nessed nearly a year ago.

“We are ready to act if needed . . . and we are open to the full menu of mone­tary pol­icy,” Mr Draghi said in Malta last week.

“The gov­ern­ing coun­cil has tasked the rel­e­vant com­mit­tee to ex­am­ine the pros and cons of var­i­ous mea­sures . . . The at­ti­tude is not wait and see but work and as­sess.”

Draghi is an en­thu­si­as­tic pro­po­nent of “for­ward guid­ance”, the strat­egy of send­ing strong ver­bal pol­icy sig­nals in or­der to shift financial mar­kets – in this case, driv­ing down the euro.

His dra­matic pledge in the sum­mer of 2012 – in the mid­dle of the Greek debt cri­sis – that the ECB would do “what­ever it takes” to save the sin­gle cur­rency helped to re­as­sure panic- stricken in­vestors.

The ECB's move to boost its mone­tary stim­u­lus, which drives down eu­ro­zone bond rates and puts down­ward pres­sure on the euro, comes as US Fed­eral Re­serve board mem­bers ap­pear deeply di­vided on whether to pro­ceed with plans to raise US in­ter­est rates this year.

While the Fed dithers, the mar­ket has al­ready ruled out an in­ter­est rate cut this year, which has pushed lower both US bond yields and the green­back.

But as it grap­ples with fee­ble eco­nomic ac­tiv­ity and in­fla­tion fall­ing into neg­a­tive ter­ri­tory, the last thing the ECB wants is to see the euro strength­en­ing against the US dol­lar. A stronger euro will act as a drag on eu­ro­zone growth, be­cause it will make the re­gion's ex­ports more ex­pen­sive in global mar­kets. And the ECB can­not stand by idly and watch as the slight progress it has made in terms of boost­ing eco­nomic ac­tiv­ity is de­stroyed by a strong cur­rency.

As a re­sult, Draghi has lit­tle choice but to fire up the print­ing presses even more by sig­nalling that the cen­tral bank's € 1.1 tril­lion bond­buy­ing pro­gram could be "re­ex­am­ined" in De­cem­ber, and by re­fus­ing to rule out fur­ther in­ter­est rate cuts.

Speak­ing af­ter the ECB’s lat­est pol­icy meet­ing in Malta, Draghi re­vealed that some mem­bers of the gov­ern­ing coun­cil had favoured tak­ing more ac­tion to stim­u­late the econ­omy im­me­di­ately.

He blamed the slow­down in emerg­ing mar­kets, in­clud­ing China, for re­newed weak­ness in the eu­ro­zone.

“While euro area do­mes­tic de­mand re­mains re­silient, con­cerns over growth prospects in emerg­ing mar­kets and pos­si­ble reper­cus­sions for the econ­omy from de­vel­op­ments in financial and com­mod­ity mar­kets con­tinue to sig­nal down­side risks to the out­look for growth and in­fla­tion,” he said in his open­ing state­ment.

Draghi said the ECB could also step up the scale of QE. A de­ci­sion is likely to be made at the De­cem­ber meet­ing of its gov­ern­ing coun­cil, when its lat­est eco­nomic fore­casts will be avail­able. As Draghi spoke, the euro dropped by 1.5 cents against the dol­lar, to $1.117.

Not sur­pris­ingly, the euro sank against the US dol­lar on Draghi's com­ments and bond yields, which move in­versely to prices, dropped sharply. Bench­mark 10-year Ital­ian and Span­ish bond yields fell to their low­est level since April, while the yield on twoyear Ger­man bonds hit a record low of 0.32 per cent.

“The gov­ern­ing coun­cil is will­ing and able to act by us­ing all the in­stru­ments avail­able within its man­date, if war­ranted, in or­der to main­tain an ap­pro­pri­ate de­gree of mone­tary ac­com­mo­da­tion,” Draghi said.

“The ECB will al­most cer­tainly be de­liv­er­ing an early Christ­mas present this year,” said Nick Kou­nis, the head of mar­kets and macro re­search at in­vest­ment bank ABN Amro.

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