Bloomberg News

Draghi Pushes ECB Closer to QE as Deflation Risks Rise

August 25, 2014

ECB President Mario Draghi

Mario Draghi, president of the European Central Bank, left, speaks with Janet Yellen, chair of the U.S. Federal Reserve during the Jackson Hole economic symposium. Photographer: Bradly Boner/Bloomberg

Mario Draghi just pushed the European Central Bank closer to quantitative easing.

With euro-area data this week likely to show the weakest inflation since 2009, the ECB president used a high-powered central-banking conference in Jackson Hole, Wyoming, to warn that investor bets on prices have “exhibited significant declines.”

Stocks rose, the euro fell and bond yields dropped to record lows today as the comments fanned speculation the ECB is finally heading for a form of monetary stimulus it has long avoided. Draghi previously said that a worsening of the medium-term inflation outlook would provide a reason for broad-based asset purchases.

The Trouble With Falling Prices

The Aug. 22 speech “was a major event and marked a turning point in ECB rhetoric,” said Philippe Gudin, chief European economist at Barclays Plc in Paris. “We think the recent economic developments have increased the chance of outright QE as the next step.”

The yield on Belgian two-year government bonds fell below zero for the first time, and Italian (GBTPGR10) 10-year yields dropped to a record-low 2.44 percent. The euro slid to the weakest rate in 11 months against the dollar and traded down 0.3 percent at $1.3204 at 4:34 p.m. Frankfurt time. The Stoxx Europe 600 Index climbed 0.9 percent, and the Standard & Poor’s 500 Index (SPX) surpassed 2,000 for the first time.

‘Stand Ready’

Euro-area inflation slowed to 0.3 percent this month, a fraction of the ECB’s goal of just under 2 percent, according to the median forecast in a Bloomberg News survey ahead of an Aug. 29 report. Other releases this week are predicted to show unemployment sticking close to a record high and economic confidence falling. Data today showed business confidence in Germany, the region’s biggest economy, slid for a fourth month.

Draghi showed his concern in his Jackson Hole speech by singling out his preferred gauge of inflation expectations. The 5-year, 5-year inflation swap rate fell below 2 percent this month for the first time since October 2011, according to data compiled by Bloomberg.

“The Governing Council will acknowledge these developments and within its mandate will use all the available instruments needed to ensure price stability over the medium term,” Draghi said at the Federal Reserve Bank of Kansas City’s annual economic symposium.

The remarks on inflation expectations were ad-libbed by Draghi. In the scripted text, he also said “we stand ready to adjust our policy stance further.” He dropped the ECB’s typical qualification that it will act “should it become necessary.”

Policy Debate

Draghi’s fear is that if inflation expectations keep falling, they’ll affect actual inflation as investors, consumers and companies pull back spending in anticipation of even weaker prices. That could tip Europe into a deflationary spiral that would be hard to reverse.

Citigroup Inc. economists last week predicted that the ECB will unveil a QE program in December valued at 1 trillion euros ($1.3 trillion), split between public and private assets and aimed at reducing borrowing costs and increasing liquidity. JPMorgan Chase & Co. said the ECB may enhance existing measures before buying bonds.

The speech “prepares the ground for a debate that may result in more action,” said Greg Fuzesi, an economist at JPMorgan in London. “It will be crucial to see both how the data evolve in the coming weeks and how policy makers more broadly respond to Draghi’s speech.”

Existing Measures

The ECB’s Governing Council next meets to set monetary policy and issue fresh economic forecasts on Sept. 4 in Frankfurt. It has so far avoided QE amid political, legal and logistical concerns over how such a program would be carried out and questions over whether it would achieve much given that bond yields in many euro-area countries have dropped to record lows.

It still may not come. Draghi didn’t mention QE directly in his speech and said he is “confident” that unprecedented measures announced in June will work.

The ECB reduced the benchmark interest rate to a record-low 0.15 percent and became the first major central bank to use a negative deposit rate. Policy makers will lend banks as much as 400 billion euros next month in the first stage of a funding program tied to real-economy loans. Officials are also “fast moving forward” with a program for buying asset-backed securities, and the euro area should benefit from a weaker currency, Draghi said.

Nomura Forecast

Nomura International Plc changed its forecast for ECB policy, saying it now expects officials to cut the benchmark interest rate and the deposit rate by 10 basis points in either September or October.

“Elements of ECB President Draghi’s speech at Jackson Hole were very dovish – and more so than we expected,” said Nick Matthews, senior economist at Nomura in London. “We believe the adjustment of the policy stance will be in the form of further easing, though without resorting to QE at this stage.”

Matthews said there is now a 30 percent chance of QE this year, up from its earlier estimate of 25 percent, and a 45 percent likelihood it will happen in 2015.

“Without doubt, Mario Draghi’s remarks at the Jackson Hole Economic Policy Symposium on sliding inflation expectations increase the odds that the ECB will embark on quantitative easing sooner or later,” said Johannes Gareis, an economist at Natixis in Frankfurt. “Still, it is far from certain that it will actually happen.”

German Weakness

Even so, the bloc’s economic weakness is looking increasingly broad. Gross domestic product stagnated in the second quarter. Unemployment (UMRTEMU) probably held at 11.5 percent in July, according to a Bloomberg survey before data this week. That’s near the record of 12 percent set last year and almost twice as high as the U.S. rate.

Business confidence in Germany, the region’s powerhouse, declined more than forecast this month, a report from the Ifo institute showed today. Escalating international sanctions against Russia because of its support for separatists in Ukraine are adding to the trade risks in the region.

France’s government resigned today amid a dispute over the direction of the euro area’s second-biggest economy. French GDP has stagnated the past two quarters and Arnaud Montebourg, the economy minister, used a weekend interview with Le Monde newspaper to call for fiscal stimulus to bolster growth.

Draghi intensified pressure on European governments to use stimulus where they can, saying “it would be helpful” if those with room to ease fiscal policy did so.

Policy Divergence

“We need action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies,” he said. “We should not forget that the stakes for our monetary union are high.”

Asset purchases would burnish Draghi’s reputation as a central banker of action two years after he pledged to do “whatever it takes” to save the single currency amid a festering sovereign debt crisis. It also would reinforce the Jackson Hole conference’s status as a source of news given then-Fed Chairman Ben S. Bernanke used it in 2010 and 2012 to signal new rounds of QE in the U.S.

The Fed is now slowing its own program and Draghi’s policy stance increasingly runs counter to that of Chair Janet Yellen. She told the symposium that the U.S. labor market has made “considerable progress” and that officials are debating when they can begin “dialing back our extraordinary accommodation.”

“The threat of a de-anchoring of expectations is being taking much more seriously,” said Beat Siegenthaler, a currency strategist at UBS AG in Zurich. “Jackson Hole 2014 might thus go down in monetary policy history not as the moment that the Fed normalization accelerated, but as the moment that QE in the euro area became a real possibility.”

To contact the reporters on this story: Simon Kennedy in Jackson Hole, Wyoming at skennedy4@bloomberg.net; Alessandro Speciale in Frankfurt at aspeciale@bloomberg.net

To contact the editors responsible for this story: Fergal O’Brien at fobrien@bloomberg.net Paul Gordon, Kevin Costelloe


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