Draghi May Reach for Bundesbank Manual When Taking Helm at ECB
May 11, 2011, 7:33 PM EDTBy Matthew Brockett and Jeff Black
May 12 (Bloomberg) -- Italy’s Mario Draghi may reach for the German policy manual when he takes the helm of the European Central Bank.
Draghi, 63, will on Nov. 1 inherit an ECB that’s almost unrecognizable from the one Jean-Claude Trichet took charge of eight years ago. The bank’s balance sheet has more than doubled to 1.9 trillion euros ($2.7 trillion), mostly as a result of the extraordinary measures it used to battle the global financial crisis and now Europe’s sovereign debt woes.
German Chancellor Angela Merkel’s endorsement of Draghi yesterday means it will fall to an Italian to steer the ECB out of a crisis triggered by southern European fiscal profligacy. Merkel made clear she’s backing the Bank of Italy governor in the expectation he will subscribe to the tight-money tradition of the Bundesbank, which provided the blueprint for the ECB when it was created 1998.
“Draghi will have to make a huge effort to assert his hawkish credentials,” said James Nixon, an economist at Societe Generale in London and a former ECB forecaster. “He may have to contend with the very real threat of a sovereign restructuring. Persuading the Germans that an Italian is the best man for that particular task is going to be difficult.”
Under Trichet, the ECB flooded markets with cheap cash and bought government bonds to prop up banks from Greece to Ireland and prevent a sovereign default. Draghi must eventually withdraw those measures to assuage fears of inflation, even as Greece struggles to repair its finances.
‘I Know Mario’
“I know Mario Draghi,” Merkel told Die Zeit newspaper in an interview published yesterday. “He’s very close to our ideas of the stability culture and solid economic policy.”
That may mean further interest-rate increases to tame inflation, which at 2.8 percent is above the ECB’s 2 percent limit. The ECB raised its benchmark rate by a quarter point to 1.25 percent in April, the first move in almost three years. Economists forecast it to tighten policy every three months.
“If, as the markets expect, Trichet raises rates in October, Draghi may find himself in the position that he’s expected to raise rates in January,” said Julian Callow, an economist at Barclays Capital in London. At the same time, economic growth may slow later this year, “so Draghi may be faced with questions about why unemployment is increasing,” Callow said. The euro area’s jobless rate stayed at 9.9 percent in March, compared with 9 percent in the U.S. last month.
‘Double-Act’
Economic pain is already acute in Greece, prompting strikes and protests against the government’s austerity drive. Ireland and Portugal -- home to ECB Vice President Vitor Constancio -- are also struggling to grow.
By contrast, Germany’s economy, Europe’s largest, is booming and unemployment is at a two-decade low, threatening to fuel wage and price pressures.
“If there has been some unease at a southern European double-act running the ECB, then the first priority for Draghi is to signal that he’s committed to delivering the ECB’s mandate,” said Ken Wattret, an economist at BNP Paribas in London.
Draghi’s candidacy has attracted criticism in Germany, and in that context, Bild, the nation’s biggest-selling newspaper, wrote on Feb. 11 that “inflation is as much a part of Italian life as tomato sauce and pasta.”
Sensibilities
Recent comments suggest Draghi is willing to placate German sensibilities. He said April 13 that monetary policy is still “accommodative” even after the ECB raised its benchmark rate that month. In February, he told Frankfurter Allgemeine Zeitung that Germany is an example for other nations, calling for tougher sanctions for budget-rule breaches and vowing to ensure price stability.
Determining withdrawal of crisis measures will test Draghi’s resolve. While the bank refrained from buying bonds for the past six weeks, its purchase program remains in place. It extended unlimited liquidity provision through the second quarter and conceded that some banks are addicted to funds. The risk for Draghi is that the longer the ECB leaves the cash tap on, the greater the threat of inflation.
Greece may be an obstacle to an exit. ECB officials have publicly opposed debt restructuring as the nation struggles to pay its creditors. Executive Board member Lorenzo Bini Smaghi warned as early as October last year that it would mean a “total collapse” of the Greek economy, while his colleague Juergen Stark told the Financial Times yesterday that a restructuring “will not resolve the Greek problems.”
Restructuring
Restructuring is “very likely” said David Owen, Managing Director of Jefferies International in London. “That restructuring event would happen on Draghi’s watch.”
Germany lost its ECB presidency candidate when Axel Weber, one of the central bank’s toughest hawks, unexpectedly announced in February he would resign as Bundesbank president. German memories of hyperinflation after World War I forged the Bundesbank’s resolve for stable prices and made it a role model for central banks across Europe, including the ECB.
Draghi “will be an orthodox, single-minded inflation fighter,” said Nick Kounis, an economist at ABN Amro NV in Amsterdam. “He will be in the Bundesbank mould as ECB president. It’s the heart and soul of the institution.”
--With assistance from Gabi Thesing and Simon Kennedy in London and Jana Randow in Frankfurt. Editors: Craig Stirling, Fergal O’Brien
To contact the reporters on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg.net; Jeff Black in Frankfurt at jblack25@bloomberg.net
To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net
