Incremental Steps

ECB Rate Moves Disappoint

Draghi-Reuters2
For the first time in a while, Mario Draghi has under-delivered.
  • Why it matters

    Why it matters

    The ECB is at risk of losing its power to persuade financial markets that it has the right prescriptions for pulling the euro-zone economy out of its prolonged slump.

  • Facts

    Facts

    • The ECB on Thursday left its main bank lending rate unchanged at 0.05 percent but cut its deposit rate by 10 basis points to –0.3 percent.
    • ECB President Mario Draghi also said the bank would extend its bond-buying program until at least March 2017, but stopped short of expanding the monthly pace of its asset purchases.
    • Financial markets reacted negatively, sending stocks lower and the value of the euro up more than 2 percent against the dollar.
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It’s not easy keeping financial markets happy these days. Mario Draghi, the European Central Bank president, is learning that lesson the hard way.

The European Central Bank said it would press ahead with its easy money policy for the 19-nation euro zone on Thursday, keeping its main bank lending rate unchanged but cutting the deposit rate for banks that park excess reserves with the central bank.

In a press conference in Frankfurt, Mr. Draghi said the central bank would extend its massive bond-buying, or quantitative easing, program until at least March 2017 – one year longer than planned. The bank said it will plow back the proceeds from bond that mature into additional bond purchases, and will expand the kinds of bonds it buys beyond federal government debt to regional and local government bonds.

The ECB’s main refinancing rate was left at 0.05 percent, at its historic low since September 2014. The bank cut the deposit rate by 10 basis points to -0.3 percent, meaning banks have to pay a fee to place extra reserve cash at the central bank rather than loan the money out.

Financial markets, however, were underwhelmed by Mr. Draghi’s initiatives, mainly because the ECB stopped short of increasing the monthly pace of its bond purchases from the current rate of €60 billion, or $64 billion.

The euro rose nearly 3 percent against the U.S. dollar following the announcement, trading at $1.0932 at 17:40 Frankfurt time. Major stock indices fell – Germany’s blue-chip DAX Index fell more than 3 percent.

Mr. Draghi’s latest moves are designed to encourage banks to lend money to businesses and individuals, stimulating European economic growth and raising inflation, which stalled at 0.1 percent in the euro zone in November. The ECB has a goal of keeping annual inflation close to 2 percent, and doesn’t expect to reach this target until 2017 at the earliest.

Some economists had called for bolder action from the ECB, warning that markets were increasingly doubting whether the ECB can meet its inflation goals. The more aggressive calls included a cut in the deposit rate by more than 10 basis points, and increasing the monthly pace of its bond-buying program by €20 billion or more.

“I am a bit surprised that the ECB has not done more given the weak inflation expectations. But it’s a difficult game. They do policy based upon what the economy needs, not what markets anticipate,” Andrew Balls, the chief investment officer of bond manager PIMCO, told Handelsblatt.

Markets had priced in an expansion in the monthly bond buys of at least €15 billion, Michael Krautzberger, head of European sovereign bonds at fund manager Blackrock, told Handelsblatt earlier this week.

It marked the first time in a long time that Mr, Draghi has disappointed – rather than positively surprised – the markets with his announcements. But for many economists, it was a sign that markets are expecting too much, rather than a sign that the ECB is reacting too timidly.

The ECB “left many market participants disappointed like small kids who receive less and smaller presents than expected on Christmas eve,” said Carsten Brzeski, the Frankfurt-based chief economist of ING-Diba bank.

The market reaction may play into the hands of Germany’s conservative economic establishment, which opposes the central bank’s strategy of deluging the market with cheap money in an attempt to stimulate lending, and economic growth. Many worry that markets have grown too accustomed to expecting ever-more easing from the ECB.

“The ECB has maneuvered itself into a dead end with its communication policy. Regardless of what it does, it can pretty much only disappoint,” Jan Holthusen, who heads research on rates and bonds for Frankfurt-based DZ Bank, said in a research note.

“We are doing more because it works, not because it fails. We want to consolidate something that has been a success.”

Mario Draghi, ECB President

Mr. Draghi shrugged off questions about whether the ECB had been too tame in its latest moves. He argued that the central bank’s initial quantitative easing program, which was launched in March of this year, had been a success.

“We are doing more because it works, not because it fails. We want to consolidate something that has been a success,” Mr. Draghi told reporters in Frankfurt. “These measures need time to be fully appreciated,” he added.

Mr. Draghi acknowledged that the central bank’s decision to press ahead with the bank’s easing policies was not unanimous among the governing council, the decision-making body that sets interest rates and monetary policy for the euro zone.

But he stressed there was a “very large majority” in favor.

Germany’s central bank, the Bundesbank, has led opponents of the ECB’s quantitative easing plans for much of the past year, but may be picking up some support even as much of the currency bloc’s economy outside of Germany continues to struggle. Central bankers from the Baltic states and Slovenia had expressed reservations about expanding monetary policy in the run-up to Thursday’s decision.

The fact that inflation will probably remain below the ECB’s 2-percent target for another two years “should not be taken lightly,” Jens Weidmann, president of the Bundesbank, said in a speech Thursday evening. “But given the dominant role that the fall in energy prices plays in the price developments of the euro zone and the extensive monetary policy measures already taken – which could also harbor risks and side effects – I did not consider further easing to be necessary.”

“should not be taken lightly,” Jens Weidmann, president of the Bundesbank, said in a speech given Thursday evening. “But given the dominant role that the fall in energy prices plays in the price developments of the euro zone and the extensive monetary policy measures already taken – which could also harbor risks and side effects – I did not consider further easing to be necessary.”

A number of economists and policymakers in Germany have argued that the ECB needs to step aside and let other actors – mainly governments – take more of the responsibility for getting the euro zone’s still-weak economy back on track. They have warned that markets have become addicted to cheap money and the central bank through its easy money policies is driving up prices for assets such as real estate to unnaturally high levels.

“The activism of the ECB is exaggerated,” Martin Wansleben, head of Germany’s largest business lobby, the Chamber of Commerce and Industry, said in a statement to Handelsblatt. “Instead of constantly coming up with new measures, more composure would have been better.”

David Folkerts-Landau, the chief economist of Deutsche Bank, said he was “disappointed that the euro zone, seven years after the start of the financial crisis, is still not in a position to stand on its own two feet and that central banks have to step in with guarantees and extreme monetary policy measures.”

“Monetary policy is compensating for the lack of progress of national governments in implementing structural reforms,” Mr. Folkerts-Landau added.

Hans-Werner Sinn, a long-time critic of the ECB and the head of the Munich-based Ifo Institute, a conservative German think tank, said he worried the ECB’s policies were no longer about raising inflation but “about rescuing ailing states and banks.”

 

078 ECB-01 Mario Draghi WTB 2014 resume

 

Others were more positive. Peter Bofinger, a member of the economic ‘wise men,’ a panel of economists who advise the German government, suggested the ECB had found the right mix. With the euro zone economy showing signs of improvement, he said he was pleased Mr. Draghi didn’t go further by expanding the monthly rate of its bond-buying.

“That was a happy surprise,” Mr. Bofinger told Berlin daily newspaper Tagesspiegel, a sister publication of Handelsblatt. “The effects of the ECB’s policies are already enormous,” he added.

The ECB also slightly lowered its forecast for euro-zone inflation in the coming years. It now expects annual inflation to be 1.0 percent in 2016 and 1.6 percent in 2017, down 0.1 percentage points from its last forecasts in September.

Mr. Draghi said the fact that the inflation expectations hadn’t fallen further was one reason why the ECB didn’t opt for more drastic measures. He said the ECB was well on a path to bringing inflation back to its declared target, which is close to but below 2 percent.

Franck Dixmier, head of fixed income at Allianz Global Investors, was also among those analysts more positive about the ECB’s latest moves, praising Mr. Draghi for fine-tuning his program rather than responding to market demands for tougher measures.

“Even if the markets reacted with disappointment, the decisions by Mario Draghi are actually good news. They show that the European Central Bank has adjusted its monetary policy to a changing macro-economic landscape,” he said in a statement.

 

Christopher Cermak is an editor with Handelsblatt Global Edition in Berlin, covering economics and financial markets. Klaus Stratmann and Katharina Slodzcyk of Handelsblatt contributed to this story. To contact the author: cermak@handelsblatt.com 

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