Mario Draghi must be feeling a lot like Father Christmas – only with an impossibly-long wish list from financial markets.
For the second year in a row, the president of the European Central Bank has signaled that he intends to deliver markets an early Christmas present – a promise to flood the economy with additional cheap money by bringing down interest rates in the 19 countries that use the euro currency.
It was in December of last year that Mr. Draghi pushed through a massive trillion-euro bond-buying program that involved buying up government debt on a grand scale. It marked the sort of bazooka of monetary policy – used by the Federal Reserve in the aftermath of the 2008 financial crisis – and was a first in the Frankfurt-based ECB’s 16-year history as the guardian of the euro-zone economy.
This year, as the central bank’s decision-making governing council prepares to meet on December 3, Mr. Draghi finds himself with little choice but to double down on last year’s promise: “We will do what we must to raise inflation as quickly as possible,” he said in a Frankfurt speech earlier this month.
That could mean firing another bazooka, either by expanding the pace of the European Central Bank’s bond-buying program, or by charging banks a higher rate to park their reserves with the central bank.
Only this time, there is growing frustration that the ECB and Mario Draghi are proving ineffective and out of fresh ideas. For some, the ECB is doing far too little and in danger of failing in its mission to keep inflation near 2 percent. For others, the central bank has already done far too much, its medicine acting like a drug that risks creating another financial market bubble in the process.
Financial markets, while demanding that Mr. Draghi do more, are increasingly doubtful that the European Central Bank will deliver on its promises. Nor do they believe the medicine being prescribed will really help raise consumer prices in the euro zone to the 2-percent level that is the ECB’s official target.
It’s a major dilemma for Mr. Draghi and his lieutenants, says Michael Krautzberger, head of European sovereign bonds at fund manager Blackrock.
“So far, Draghi has always very cleverly monitored the market, and met or even exceeded its expectations. But this is leading to a kind of vicious circle: The markets keep expecting more, placing the ECB under pressure to always do more. Only this time, it may disappoint the markets,” Mr. Krautzberger told Handelsblatt.
He is not the only one who worries that Mr. Draghi has been placed in a quandary. The ECB Shadow Council, an unofficial panel of top European economists convened by Handelsblatt about once every three months to debate the ECB’s policies, was fiercely divided during a conference call Friday over whether the central bank needs to double down or turn off the money spigot for now.
“We should not let the ECB buy up all the junk that is the result of a massive cycle of over-investment and excessive risk-taking by the private sector.”
Of the 15 economists that are members of the Shadow Council, the slimmest majority of eight called on the central bank to lower its deposit rate further into negative territory.
The deposit rate – a positive interest rate in normal times – has been effectively been turned into a tax on banks since September of last year. Banks are currently being charged 0.2 percent by the ECB to park their excess reserves with the central bank. The idea is to prod banks to lend out the money instead, and many economists now believe the central bank should raise this tax even further.
“This isn’t the time to be cautious in terms of the policies that are being delivered,” said Janet Henry, chief economist of British bank HSBC and a member of the Shadow Council.
Others demanded the central bank expand and extend its monthly bond-buying program. Since March, the ECB has been buying about €60 billion, or $63.5 billion, in government bonds and other securities each month. It has promised to continue the “quantitative easing” program until September, though many now expect the ECB to extend this timeline into 2017. Some have called for the pace of monthly purchases to be expanded by as much as €30 billion.
For those like Ms. Henry who believe the ECB should be more aggressive, it’s a simple matter of credibility. The ECB’s central declared goal is to keep inflation close to but below 2 percent. With consumer prices currently rising at just 0.1 percent per year, there is frustration that the ECB hasn’t been even more ambitious. Market measures of where investors expect inflation to be in five years have been showing that many no longer expect the ECB to reach its target.
“The policy response needs to be bold,” said Andrew Bosomworth, another member of the Shadow Council who leads the German division of bond manager PIMCO. He argued better to act “quickly and forcefully” than to drag monetary easing out over a longer period of time.
“The main risk I see is the de-anchoring of inflation expectations….that is really not to be underestimated,” Mr. Bosomworth, another Shadow Council member, added.
“This isn’t the time to be cautious in terms of the policies that are being delivered.”
Will the ECB deliver? Mr. Krautzberger of Blackrock warned that financial markets have already priced in additional bond-buying of at least €15 billion and a deposit rate cut of 0.1 percent.
But it’s not clear the ECB is on the same page. The trouble is that such calls for more aggressive action are hardly shared by all economists, nor are they shared by all members of the European Central Bank itself.
Compared to last January, when Mr. Draghi could count on broad support for his first quantitative easing plan, he can expect to meet much heavier resistance this time around. Jens Weidmann, the president of Germany’s central bank, the Bundesbank, is unlikely to be the only governing council member to oppose the ECB’s president.
Other opponents of additional easing include the three Baltic nations, Slovenia’s central bank head, and Sabine Lautenschläger, a member of Mr. Draghi’s inner-circle of executive board members based in Frankfurt.
Ms. Lautenschläger in November made clear she sees “no reason at the moment for additional monetary measures, above all not for an expansion of the bond-buying program.”
For opponents, the risks simply outweigh the rewards. Many worry that the ECB could be making the European financial system more unstable, not less. Some Shadow Council members warned that the ECB’s policies could be feeding bubbles in the economy by driving asset prices up higher than they should be, while others pointed to the effect that low interest rates have on the profits of smaller banks.
“The goal of [ECB] measures is to stimulate the economy and strengthen the banking system. Zero and negative interest rate policies and asset purchases are designed to do the opposite: they reduce the profit margins of traditional banks that engage in traditional SME lending by flattening the yield curve around zero,” said Richard Werner, an economics professor at the University of Southampton. “Negative rates are simply a tax on banks.”
Others simply argued the ECB can afford to wait. While inflation may be low and the euro zone economy still weak, it is at least recovering and no longer in the middle of an acute financial crisis. The danger, according to Jose Luis Alzola, a senior economist with the Observatory Group, is that the ECB will use up all its tools and be out of options if the economy takes another serious dip in future.
“We have seen signs recently that the economy is picking up again,” Mr. Alzola said, but added: “A tightening of financial conditions…can derail the recovery. For that purpose, these types of [ECB] measures have to be kept, with the powder dry to be used at that stage rather than now.”
There is one thing that both sides agree on: The ECB cannot bring the euro-zone economy back to life on its own. European governments and banks, both still struggling with an overhang of bad debt from the 2008 financial crisis, need to step up to the plate instead by getting their house in order and spending additional money where they can.
Willem Buiter, chief economist of Citigroup and another Shadow Council member, argues that while the ECB does need to lower interest rates further, it needs help from the private sector if the euro zone economy is ever to truly get back on its feet.
“We should not let the ECB buy up all the junk that is the result of a massive cycle of over-investment and excessive risk-taking by the private sector,” Mr. Buiter said. “This restructuring should take place independent of the central bank – and we had better get on with it.”
Christopher Cermak is an editor covering finance and the economy for Handelsblatt Global Edition in Berlin. Jan Mallien is a correspondent covering monetary policy for Handelsblatt in Frankfurt. Andrea Cünnen of Handelsblatt also contributed to this story. To contact the authors: email@example.com and firstname.lastname@example.org