STIMULUS HINTS
Bank’s remaining ammo is limited
The ECB will ease policy again if inflation fails to accelerate, its president says.
SINTRA, PORTUGAL: The European Central Bank will ease policy again if inflation fails to accelerate, ECB president Mario Draghi says, signalling one of the biggest policy reversals of his eight-year tenure.
After four years of unprecedented stimulus to revive the euro zone economy after its debt crisis, the ECB had been preparing markets for policy tightening, dubbed “normalisation” — only to see a global trade war unravel its plans within a matter of months.
The problem is that with rates at record lows and the ECB’s balance sheet already swelled to €4.7 trillion ($5.3 trillion), its remaining ammunition is limited, raising doubts about the likely effectiveness of any further measures.
“In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required,” Draghi told the ECB’s annual conference here yesterday.
With just four months left of his term, the slowdown is also a threat to Draghi’s legacy.
The Italian’s promise in 2012 to do “whatever it takes” to save the euro is widely credited with holding together the currency bloc during the darkest days of its crisis.
“(We) will use all the flexibility within our mandate to fulfil our mandate — and we will do so again to answer any challenges to price stability in the future,” Draghi said. “Monetary policy remains committed to its objective and does not resign itself to too-low inflation.”
But Draghi is not alone in having to backtrack.
The US Federal Reserve first abandoned interest rate hikes and may this week signal cuts in borrowing costs as global turmoil erodes confidence, hitting stocks and global trade.
Draghi said the ECB, which has consistently undershot its inflation target of just under 2% since 2013, could still cut rates, adjust its interest rate guidance and had “considerable headroom” for more asset purchases.
He also said the ECB could offer “mitigating measures” to offset the unwanted side effects of negative rates, a comment indicating that a multi-tier deposit rate was also on the table.
Adding an argument for urgency of action, he noted that growth risks were tilted to the downside and indicators for the coming quarters point to lingering softness.
The ECB would now use the “coming weeks” to study its options, Draghi said, suggesting that action may come sooner rather than later.
The comments, which markets saw as unexpectedly dovish, sent the euro down by a quarter of a percent against the dollar while stocks erased early losses and bond yields fell further, many into record-low territory.
Markets have already priced in 15-20 basis points of cuts in the ECB’s -0.40% deposit rate — a big change compared to the start of the year, when rate hikes were firmly on the table.
Not everyone was convinced, given the ECB’s relatively depleted policy arsenal.
“It is rather easy to agree with the ECB that it still has policy options at its disposal,” Nordea economist Jan von Gerich said. “It is much harder to argue that the further steps the Governing Council is likely to be willing to take would make monetary policy significantly easier.”
But Draghi dismissed many of those concerns, particularly about the effectiveness of further bond purchases, arguing that the ECB’s self-imposed limits, such as a rule that prevents it buying more than one-third of a particular country’s debt, were open to adjustment.
“The limits are flexible because the ECB’s legal powers allow it to deploy tools that are both necessary and proportionate, and that the European Court of Justice had already confirmed it had broad discretion,’’ he said.
Although the ECJ cleared the asset purchases in an earlier ruling, it argued that limits on the ECB’s buys must be in place, suggesting that any change in those limits could land the central bank back in court.
The ECB sees inflation at 1.4% next year and market-based inflation expectations point to a slowdown in the years ahead.
But Draghi said the ECB would not accept low inflation and would fulfil its mandate, even if fiscal policy did not provide the necessary support.
“We are committed, and are not resigned to having a low rate of inflation forever or even for now,” he said. “That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future.”
The ECB next meets on July 25.