Mario Draghi has been missing his most important target for over three years.
The president of the European Central Bank is meant to keep inflation in the 19-nation euro zone at close to 2 percent. More than anything else, that is the central bank’s job, or “mandate.”
Yet year after year, the development of consumer prices in Europe has continued to weaken. Prices in the euro zone fell by 0.2 percent year-on-year in April and fell again by 0.1 percent in May, according to the latest statistics released Tuesday. It marked the third time in four months that consumer prices were negative.
Even in Germany, Europe’s largest economy and a country that has seen solid growth and record low unemployment, consumer prices rose by just 0.1 percent year-on-year in May, according to figures announced by Germany’s Federal Statistical Office on Monday.
The ECB’s target seems further away than ever.
Now, however, there is a glimmer of hope for Mr. Draghi: the oil price.
“If the oil price stays at its current level, inflation for the first quarter of 2017 will quickly rise to 1.7 percent. The ECB would thus have more or less fulfilled its mandate.”
The oil price has been on a wild ride in 2016. Early this year, it slumped to below $30 per barrel. Since then, it has risen again by more than 75 percent, at times exceeding the psychologically-significant threshold of $50 per barrel.
This could mean that the ECB reaches its inflation target faster than anticipated. Mario Draghi’s vaunted 2-percent inflation target may actually be in reach much sooner than many people expect.
“If the oil price stays at its current level, inflation for the first quarter of 2017 will quickly rise to 1.7 percent,” said Sylvain Broyer, chief economist at French investment bank Natixis in Germany, adding that for the year as a whole, inflation could then be 1.5 percent. “The ECB would thus have more or less fulfilled its mandate.”
The higher expectations are due in part to the so-called base effect, whereby abnormally low or high inflation levels for a previous period distort the figures for the most recent period. Because oil prices were so low at the beginning of 2016, they could grow more strongly in 2017 compared with this base level.
Not everyone is convinced that oil will provide such a boost, however, or that it will be long-lasting. The ECB Shadow Council, a group of 15 top European economists convened by Handelsblatt once a quarter to discuss monetary policy, argued the central bank should continue to hold its course on monetary policy. The group on average forecast that inflation will rise 1.2 percent year-on-year in 2017 – still below the ECB’s target.
The ECB itself in March forecast annual inflation of 1.3 percent for next year. It could well adjust that estimate when it presents new forecasts for growth and inflation, both for 2017 and for the first time for 2018, on Thursday.
The ECB relaxed its monetary policy dramatically in March, largely owing to the decline in oil prices. In June, it will start a new policy of buying corporate bonds.
This was a controversial step. Jens Weidmann, head of Deutsche Bundesbank, Germany’s central bank, opposed the new measures and argued that the ECB should not be guided by fluctuations in the oil price.
However, Mr. Draghi and other members of the ECB’s governing council feared that the slump in oil prices could be due to declining demand in emerging countries, which could adversely affect the upturn in the euro zone. There were also concerns about “second-round effects,” whereby falling oil prices could put pressure on prices for other goods and services, such as air travel, or could cause employers and trade unions to agree to lower wages in the expectation that prices will rise at a slower rate.
Even if oil is expected to provide a boost, other prices in the euro zone still aren’t expected to rise sharply any time soon. The euro zone’s so-called “core” inflation rate, which excludes the more volatile oil prices, also remains well off the ECB’s 2-percent target.
Core consumer prices in the euro zone rose 0.8 percent year-on-year in May, up 0.1 percentage points from April, according to figures released Thursday.
“We do not think higher core inflation in May will be the start of a new trend, ” said Gizem Kara, a senior European economist for French bank BNP Paribas. “Looking beyond monthly volatility, we expect it to hover around its current level for the rest of the year, thanks to the copious amount of slack in the economy and the impact of past euro strength.”
Still, fears that consumer prices will fall even further may have abated somewhat following the recovery in oil.
The oil price dropped from $110 per barrel in mid-2014 to a temporary low of $27 at the beginning of 2016. That pushed down inflation around the world and made life difficult for Mario Draghi.
The ECB president used all available monetary policy tools to counteract falling prices, largely in vain. What is paradoxical is that a higher oil price could have a faster and more powerful impact than any of the tools employed by the central bank to date.
Some economists, such as Mr. Broyer at Natixis, are already calling on the ECB to develop a plan for ending its lax monetary policy. The ECB’s bond purchases, which currently total €80 billion ($89 billion) a month, are scheduled to continue until March 2017.
“If the ECB wants to avoid harsh criticism from northern European euro-zone countries, it should work out the terms for withdrawal now and announce them between fall and the end of the year,” Mr. Broyer said.
Michael Heise, chief economist at German insurer Allianz, also expects inflation to climb to 1.6 percent in 2017. If that prediction pans out, he believes there would then no longer be any justification for bond purchases.
“The ECB should therefore prepare the markets for a gradual withdrawal by 2017 at the latest,” he said.
However, the dramatic fluctuations in the oil price make the management of monetary policy very difficult. In a recent survey by the news agency Bloomberg, 67 percent of those questioned said they were still expecting the ECB to relax its policy further in future.
It became apparent in March just how sensitive the markets are to any talk of the end of ECB easing.
Mr. Draghi announced a massive relaxation of monetary policy at a press conference following a meeting of the ECB’s governing council – yet the markets were disappointed. His comment that there would be no further interest rate cuts in the foreseeable future caused concern that the ECB had reached the end of the line.
The first step toward a turnaround could be the most difficult. In the United States, for example, there was turmoil when Ben Bernanke, the former head of the Federal Reserve, the U.S. central bank, first speculated about an end to bond purchases in June 2013. This was a long time before it actually occurred. Mr. Broyer said this example highlights the importance of preparing very carefully for the end of bond purchase programs.
Before this can actually be discussed, however, it must be established how sustainable the growth in oil prices actually is. Only time will tell.
It is a strange coincidence that the ECB’s governing council meeting on Thursday will take place in Vienna, on the same day that the oil cartel OPEC holds a meeting to decide on the oil production levels.
While there has been an over-supply of oil on the market in recent years, this is likely to come to an end by 2017, according to the International Energy Agency. Sultan Bin Saeed al-Manssori, the economics minister of the United Arab Emirates, is even more bullish. He expected prices could rise to $60 per barrel by the summer as demand in the United States heats up.
Other experts warn that Mr. Draghi shouldn’t be shouting for glee just yet. There are a number of reasons that speak against a sustained rise in oil prices.
The main reason is that supply could increase again: Experts from oil consulting firm Rystad Energy reckon that fracking – a costly new form of oil production that was the primary reason for over-supply and price collapse in the past – could become profitable for some U.S. companies again once the price climbs above $50 per barrel. That in turn could stop prices from rising even further.
Jan Mallien is Handelsblatt’s correspondent in Frankfurt covering monetary policy. Christopher Cermak of Handelsblatt Global Edition and Matthias Streit of Handelsblatt contributed to this story. To contact the author: firstname.lastname@example.org