Draghi awaits pivotal price data after backing rate cuts to QE
Stefan Riecher & Alessandro Speciale
The most-radical policy decision of Mario Draghi’s 2 1/2 years so far at the helm of the European Central Bank could hinge on a single piece of data.
A weak inflation reading on April 30 will probably see the ECB president facing calls to act as soon as next week by imposing negative interest rates for the first time or pushing forward with plans for quantitative easing. Economists in a Bloomberg News survey predict consumer prices rose 0.8 percent this month from a year ago, compared with 0.5 percent in March.
A lower-than-forecast number would undermine the ECB’s view that inflation should rebound as temporary distortions pass and the economy recovers. Draghi has been increasingly explicit about what might prompt action if it doesn’t, saying that broad- based asset purchases are possible should the medium-term outlook for prices worsen.
“If inflation doesn’t pick up from last month, then it’s game over for wait-and-see,” said Richard Barwell, senior economist at Royal Bank of Scotland Group Plc in London. “I expect prices to recover from last month and the ECB to play for time if they can.”
Estimates for April inflation range from 0.7 percent to 0.9 percent, according to the Bloomberg survey of 37 economists. Price gains have been below 1 percent since October, compared with the ECB’s goal of just under 2 percent, and March’s figure was the weakest in more than four years.
Should this week’s data miss estimates, the ECB is more likely to cut interest rates, according to Credit Agricole CIB. The benchmark main refinancing rate has been at a record-low 0.25 percent since November and the deposit rate at zero since July 2012.
“If April inflation undershoots expectations, it would strengthen the case for early ECB action in May,” said Frederik Ducrozet, an economist at Credit Agricole in Paris. “The first step would be a cut in the refi rate and possibly a liquidity- easing measure. For QE, inflation needs to remain stable without rebounding.”
Other indicators this week include confidence surveys tomorrow and unemployment on May 2. The picture is likely to be mixed. Economic confidence climbed to the strongest since July 2011, while the jobless rate held near a record high at 11.9 percent, according to separate Bloomberg surveys.
“A pickup in the euro area’s growth momentum does not immediately translate into higher inflation numbers, given the large extent of slack in the economy,” said Johannes Gareis, an economist at Natixis in Frankfurt. “A significant undershooting of the ECB’s inflation target in the foreseeable future is likely to be the norm rather than the exception.”
The ECB left its monetary policy unchanged on April 3 and Draghi told reporters afterward that fluctuations in energy prices and the timing of the Easter holidays “may well produce higher inflation” this month. The next rate-setting meeting will be on May 8 in Brussels.
This week’s data “will be a very important element to see if there are again negative surprises, which would clearly show that there are more structural elements at work that we have underestimated,” ECB Governing Council member Luc Coene said in Amsterdam last week.
Other policy makers have warned against rushing to a decision.
“We’ll only be able to really judge” any potential deflation threats in June, when the ECB revises its macroeconomic forecasts, Ewald Nowotny, the head of Austria’s central bank, said in an interview with Der Standard on April 23. “I believe that until then we shouldn’t take any measures.”
Speaking in Amsterdam on April 24, Draghi provided his most detailed explanation yet of the ECB’s thinking on policy by outlining three contingencies.
The first would be an unwarranted monetary tightening, which he said could be caused by higher short-term money-market rates, rising global bond yields, or an appreciation in the euro. Those factors could be addressed by conventional measures including rate cuts, an extension of fixed-rate, full-allotment operations, and longer-term loans to banks, he said.
The overnight cost of interbank borrowing in the euro area was at 0.331 percent on April 25, after averaging 0.192 percent in March and 0.157 percent in February. The euro has climbed more than 6 percent against the dollar in the past 12 months.
The second contingency would be impairments in the transmission of monetary policy, which could be tackled with targeted loans to banks or the purchase of asset-backed securities. The ECB and the Bank of England have called on international financial regulators to ease rules to bolster the ABS market.
The third scenario would be a worsening of the medium-term inflation outlook, either because of a broad-based weakening of aggregate demand or a shock that loosens the anchoring of inflation expectations. Draghi said that would require the ECB to “meaningfully” ease monetary policy and would “be the context for a more broad-based asset-purchase program.”
While that points toward large-scale bond buying similar to the QE programs run by the U.S. Federal Reserve and the BOE, it would probably be a controversial step. The ECB is banned from monetary financing of governments, making sovereign-debt acquisitions problematic. Even so, it has run models simulating purchases of as much as 1 trillion euros ($1.4 trillion) of bonds.
“We maintain our view that a sizable worsening of the medium-term outlook will be needed for a broad-based QE program,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. This week’s data “will be crucial to confirm the temporary nature of the recent inflation weakness.”