Mario Draghi has surprised markets by cutting rates by less than expected, and extending, rather than increasing, the QE programme. Is it a sign of economic recovery, or complacency?
What happened?
Citing the low level of inflation, which was substantially below the ECB’s target of 2%, Mario Draghi announced at his monthly press conference that he had decided to loosen monetary policy further, cutting the deposit rate by ten basis points to -0.3%. This means that banks will have to pay the ECB money to leave money with it, encouraging them to lend it out to firms and households.
He also extended the ECB’s QE programme by six months, so that it will end in March 2017, rather than September 2016 (though it could continue beyond then). And he announced that the ECB would consider broadening the type of assets that it buys, to include local and regional government debt, rather than simply national bonds.
How have the markets reacted?
The general feeling has been one of surprise, since most people were expecting more aggressive cuts and a steep increase in the monthly purchases. Jonathan Loynes of Capital Economics is particularly scathing, calling it a “clear disappointment in the light of the repeated extremely dovish signals from the President and his colleagues”. Overall, he believes that “the ECB has comprehensively failed to live up to its own hype and markets and forecasters will take future communications from Mr Draghi and colleagues with a corresponding bucket of salt”. Neil Williams of Hermes Capital Management is similarly disappointed, calling it “puny” and saying that Draghi has “under-delivered”.
The euro quickly increased in value, while expected bond yields on eurozone government debt have increased.
So, why did Draghi back down?
The optimistic explanation for the apparent change in direction is that since the eurozone is slowly recovering, with economic growth expected to be 1.5% this year, there is less need for a large stimulus. In his statement, Draghi said that, “we expect the economic recovery to proceed” with domestic demand “further supported by our monetary policy measures and their favourable impact on financial conditions”. Additionally, “low oil prices should provide support for households’ real disposable income and corporate profitability”. However, this is unlikely to be full explanation since eurozone unemployment is still 10.7%.
Draghi pointed to “subdued growth prospects in emerging markets and moderate global trade, the necessary balance sheet adjustments in a number of sectors and the sluggish pace of implementation of structural reforms”.
Is the ECB split on QE?
Another explanation for the surprise decision is that there is growing opposition to further monetary stimulus. Even before the decision, the Financial Times warned that, “German-led opposition threatens to limit its firepower”.
Last month, Sabine Lautenschlaeger, a member of the ECB’s executive board stated that she saw “no need for further monetary-policy measures, especially not for an expansion of the asset-purchase program”. Instead, she argued that, “We should give the numerous and, all-in-all formidable, monetary-policy efforts time to show their full effects”.
Estonia’s Central Bank governor Ardo Hansson also stated in October that “we should be patient and give these policies a bit more time to have an effect”.