Draghi Braves QE Hype With Boost That Leaves ECB Room to Do More

  • ECB keeps monthly buying at 60 billion euros, extends to 2017
  • Municipal, local debt added to asset-purchase program

The European Central Bank unveiled a package of measures to tackle too-low inflation, from a cut in the floor for interest rates to an expansion of its bond-buying program by at least 360 billion euros ($390 billion). Investors were unimpressed.

The Frankfurt-based ECB will extend quantitative easing by six months until at least March 2017 at the current rate of 60 billion euros a month, and broaden the assets purchased to include local and regional debt, ECB President Mario Draghi said on Thursday. The Governing Council earlier reduced its deposit rate by 10 basis points to minus 0.3 percent.

The fresh stimulus coincides with a shift in global monetary policy, with the ECB adding stimulus as the U.S. Federal Reserve prepares to start its process of normalization. Even so, financial markets reacted with skepticism, sending the euro up as much as 2.6 percent and equities and government bonds down in a sign that Draghi’s measures fell short of expectations.

“The expectations were too high, and this was the minimum he could do,” said Marco Valli, chief euro-area economist at UniCredit SpA in Milan. “I think this was a mix of Draghi being held back by the conservatives, but also him wanting to keep some powder dry in case more is needed.”

Euro Surge

The euro was up 2.2 percent at $1.0845 at 4:51 p.m. Frankfurt time, after climbing as high as $1.0892. The Stoxx Europe 600 Index was down 2.8 percent. Euro-area two-year note yields jumped from record lows and Italy’s 10-year yield climbed by the most since June.

While all economists in a Bloomberg survey forecast action, some predicted a bigger cut to the deposit rate as well as an increase in the monthly rate of purchases.

In a press conference, Draghi confirmed that the Governing Council’s decisions were not unanimous, though said there was a “very large” majority in favor. That implies opponents may have been limited to open skeptics such as Bundesbank President Jens Weidmann and Executive Board member Sabine Lautenschlaeger.

Yellen Testimony

German policy makers have emphasized the steadiness of the economic recovery and played down the importance of low inflation, arguing against the need for further stimulus now.

Draghi said the measures will need time to be appreciated, and called the cut in the deposit rate “adequate.” It will “vastly improve” the transmission of monetary policy, he said.

“Today’s decisions were taken in order to secure a return of inflation rates that are below or close to 2 percent and therefore to anchor medium-term inflation expectations,” he said. “We are doing more because it works.”

Separately, Fed Chair Janet Yellen delivered a cautiously upbeat outlook for the U.S. economy on Thursday, signaling the conditions necessary for an interest-rate increase have been met and that she hopes to tighten monetary policy slowly.

Draghi Pledge

“I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market,” she said, according to the text of a testimony before Congress’s Joint Economic Committee. “Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent.”

The recovery in the 19-nation euro area hasn’t been rapid enough to bring inflation back toward the ECB’s definition of price stability, or annual gains of below but close to two percent. The rate remained at 0.1 percent in November and the core rate, stripping out the effect of energy and food-price swings, slipped to 0.9 percent from 1.1 percent. The ECB has argued that very low price gains run the risk of accidentally tipping the economy into deflation.

Draghi signaled more stimulus six weeks ago and reiterated his pledge in a Nov. 20 speech, when he declared that officials “will do what we must to raise inflation as quickly as possible” using all available instruments within their mandate.

Principal Reinvestment

Draghi also announced that the ECB will reinvest the principal payments on the assets it purchases under QE. Details of that and the inclusion of debt issues by local and regional authorities will be communicated “in due time.” The ECB will continue to offer banks as much liquidity as they demand at least until the end of 2017.

The reinvestment of principal payments “is quite an important measure,” Draghi said. “It basically says that we intend to maintain the degree of monetary accommodation and favorable conditions for liquidity for a longer horizon than we had been saying so far.”

Executive Board member Yves Mersch said in Munich later that the reinvestment was “the most important element” of the policy decision. He said QE has prevented deflation and possible recession and the impact of the policy so far shouldn’t be underestimated.

“The ECB delivered a slightly lighter easing package than we had expected and much easier than many markets participants had expected, or hoped for,” Nordea Markets economists Holger Sandte and Jan von Gerich wrote in a note to clients. “A further cut in the deposit rate would probably be the easiest next step for the ECB, while an increase in the monthly pace of the purchases would be a bigger step. The ECB wants to keep all doors open.”

Presenting fresh economic forecasts, Draghi said the ECB decided to revise down its inflation outlook “slightly.” The forecast for 2016 was cut to 1 percent from 1.1 percent, and for 2017 to 1.6 percent from 1.7 percent. The prediction for economic growth in 2016 was kept at 1.7 percent and for 2017 was revised higher to 1.9 percent from 1.8 percent.

Economic data since October, when Draghi dropped heavy hints that further stimulus would be in the pipeline, haven’t conclusively worsened or improved. While third-quarter growth data showed the economy expanding at a slightly slower pace than the previous three months, consumer confidence remains relatively high amid robust domestic demand.

That said, Draghi sounded a negative tone on the outlook for the region’s economy.

“The economic recovery in the euro area continues to be dampened by subdued growth prospects in emerging markets and moderate global trade,” he said. “These risks have the potential to weigh on global growth and foreign demand for euro-area exports and on confidence more widely.”

Draghi reiterated that the central bank has more ammunition at its disposal if needed, though Thursday’s action should suffice.

“We’re not excluding the use of all other instruments if we were to decide they were the right ones to do,” Draghi said. “I said before that the cut we decided today is adequate. Period.”

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