Mario Draghi said the European Central Bank (ECB) might start broad-based asset purchases if the inflation outlook worsens as he prepares the ground for one of the most radical policies in the ECB’s history.
“The objective here would not be to defend the current stance, but rather to increase meaningfully the degree of monetary accommodation,” the ECB president said in a speech in Amsterdam today. “The Governing Council is committed—unanimously—to using both unconventional and conventional instruments to deal effectively with the risks of a too-prolonged period of low inflation.”
Draghi’s comments are his most explicit so far on what would prompt action similar to the quantitative easing programs at the U.S. Federal Reserve and Bank of England. Inflation data next week will give further clues as to whether consumer-price gains are accelerating as the economy recovers or if the euro area is teetering close to deflation.
“Draghi was very precise in explaining when and how the ECB will choose to act,” said Johannes Gareis, an economist at Natixis in Frankfurt. “The ECB is unlikely to embark on broad-based asset purchases unless the ECB feels real deflationary risks.”
The euro fell after Draghi’s comments. It was little changed at $1.3811 at 4:38 p.m. Frankfurt time. Germany’s benchmark 10-year bond yield slid five basis points to 1.517 percent.
Inflation in the 18-nation currency bloc slowed to 0.5 percent last month, the weakest pace in more than four years and well below the ECB’s goal of just under 2 percent. While that prompted Draghi to say on April 3 that policy makers are willing to use unconventional measures, including asset purchases if needed, he also said the figure was depressed by temporary factors such as lower energy and food prices and the timing of Easter. This month’s data is due on April 30.
“While inflation will remain low for a prolonged period, we see it gradually rising back to 2 percent,” Draghi said today. “The delay is largely explained by the impairments in the transmission mechanism that lengthen the lag between our accommodative policy stance and price developments.”
Draghi said that any asset-purchase program “should certainly take into account the heterogeneity, the fragmentation let’s call it, of our euro-area system, if that is relevant for the effectiveness of the purchase program.”
His words echo comments made by Executive Board member Benoit Coeure on April 13 in Washington. Coeure warned that “segmentation would have to be taken into consideration” to ensure a purchase program in the euro area achieved a “homogeneous reduction” of longer-term interest rates.
Draghi said that the ECB doesn’t see broad-based deflation risks, while adding that a stronger euro exchange rate does threaten the outlook for prices.
“A rise in the exchange rate, all else being equal, implies a tightening of monetary conditions, a downward impact on inflation, and potentially a threat to the ongoing recovery,” he said. “If so, this would call for policy action to maintain the current accommodative stance.”
An unwarranted monetary tightening because of euro strength could be addressed by conventional measures including cuts in official interest rates, he said. The ECB has kept its benchmark main refinancing rate at a record-low 0.25 percent since November, and the deposit rate has been at zero since July 2012.
ECB Governing Council member Luc Coene said later in Amsterdam that a strong euro “certainly is a problem” in that it puts downward pressure on prices that are already low, and reiterated Draghi’s comments on the possible policy response.
“If you only cut the main refinancing rate, that is going to be a very small adjustment that will not have sufficient impact on the markets,” he said. “You should cut both and bring the whole corridor down.”
Conventional policy action could also be warranted by tensions in short-term money markets “in an environment of receding excess liquidity in the euro area,” Draghi said.
Excess liquidity in the euro-area financial system has dropped to 92.9 billion euros (US$128 billion), the lowest level since December 2011, the ECB said today. The decline is adding to pressure on the ECB to curb money-market tensions, according to strategists at Rabobank.
Draghi also said publishing minutes is the “logical next step” in the ECB’s efforts to improve transparency and accountability, and this might in turn trigger a reflection on how often the bank decides on monetary policy.
“It’s very clear that the frequency of our meeting leads the public and the market to expect action,” he said, adding this was his view and not necessarily the Governing Council’s.
The ECB holds a rate-setting meeting once every month, more often than other central banks such as the Fed. The Bank of Japan is scheduled to hold 14 monetary policy meetings in 2014. The ECB’s next rate meeting is on May 8 in Brussels.
“It’s obvious that the frequency we have now is leading to some pressures to act more frequently than basically is needed in a medium-term framework,” said Coene. “So you could argue that maybe it would be more optimal to have policy meetings not at every month, but at a greater interval.”