The European Central Bank on Thursday formally announced the beginning of the end of its loose monetary policy — but its president, Mario Draghi, managed to convey the impression that he isn’t changing a thing.
The ECB announced in a widely expected decision that it would next year halve to €30 billion its monthly purchases of government and corporate bonds, which have kept long-term interest rates low in the last two years and supported the eurozone’s economic growth.
In a press conference afterward, it then fell on Draghi to put the most “dovish” spin ever put on a decision that would have been called “hawkish” in any other context.
It seems to have worked.
Markets took the change in the ECB’s so-called quantitative easing or QE program in stride, with bond prices and the euro exchange rates barely moving on the news.
The ECB president has some reason to rejoice at managing to keep the bank’s policy on the loose side, against the wishes of the most hawkish members of its governing council. But Thursday’s decision also reflects the headwinds the ECB faces in trying to fulfill its sole mandate: Keep inflation in the eurozone “below but close” to 2 percent a year.
The ECB is still far from that target: It expects prices to rise 1.5 percent this year and only 1.2 percent in 2018 due to lower energy prices. In other words, Draghi cannot claim mission accomplished quite yet.
The ECB’s key interest rates will remain at rock bottom “well past the horizon”
There are other reasons for the ECB to pursue its “accommodative” monetary policy, to use central bankers’ lingo. True, the eurozone is in the midst of an economic recovery that has exceeded expectations — with 7 million jobs created in the last four years, Draghi noted. Yet growth, expected at 2.1 percent this year after 1.8 percent in 2016, is likely to slow in 2018. And most of the eurozone economies are far from running at full capacity.
It’s also easy to see how potential economic headwinds could push the eurozone back into crisis mode. Interest rates rising too fast, for example, would push Italy, a country Draghi knows well, into danger zone in an uncertain election year. Italy’s public debt — at 135 percent of GDP — would put it at the mercy of investor panic if the ECB wasn’t propping it up in the bond market.
This is why Draghi has kept all the flexibility he needs to reassure both markets and policymakers that he can switch back to full QE at short notice. Furthermore, the ECB’s key interest rates will remain at rock bottom “well past the horizon” of the eventual end of bond buying, which was originally planned to end in December but now prolonged until September 2018 — or even later.
And as if that weren’t enough, the central bank committed to reinvesting the proceeds from the €2 trillion-odd worth of bonds it now holds in its portfolio when they mature. This will guarantee that the ECB remains the key driver of the market for those bonds — and market interest rates — for the foreseeable future.
The stock exchange in Frankfurt am Main | Daniel Roland/AFP via Getty Images
The ECB’s latest policy decisions were not unanimous, Draghi said. Some council members notably advocated a firm commitment to end it by a certain date. But Draghi prevailed on keeping the QE program “open-ended” or “until the governing council sees a sustained adjustment in the path of inflation consistent with its inflation aim,” the ECB said in its official press release.
One area where Thursday’s decision is unlikely to help Draghi is in foreign exchange markets. The euro has remained strong, appreciating 12 percent against the dollar and nearly 5 percent against the pound this year. That in turn puts a damper on inflation by making imported goods cheaper.
Even though the ECB’s mantra is that the exchange rate is not among its targets, a weakening of the euro would help it reach its inflation goal.
That’s not in sight yet either.