Draghi Fails to Say Anything New, Status Quo Persists

The ECB shrugged off calls from the OECD and the IMF to ease policy. Nor did the ECB make technical moves, like reducing the rate corridor by cutting the 75 bp lending rate. By arguing that inflation expectations are firmly anchored, Draghi seems to have initially dampened speculation of more dramatic action next month.

It does seem a bit disingenuous of Draghi to complain again about the policy recommendations from the IMF and OECD, which called on the central bank to ease policy. Surely, such unsolicited advice does not really amount to a threat to the ECB independence or its credibility. The thing that hurts ECB credibility in the eyes of many investors is the talking without action. 

The fact that low inflation, high unemployment, fragile economies and the strong euro does not elicit a policy response arguably does more harm to the ECB’s credibility than the IMF or OECD. How long can Draghi tease the market without gratifying it? Draghi, of course, repeated that the central bank is unanimous in supporting unconventional policies if necessary. The ECB has been saying for more than a year that it is prepared for a negative deposit rate. The reference to unconventional policies also includes the possibility of asset purchases.

After making new highs for the year while Draghi was talking, the euro reversed course and fell to new lows on the day. The market seemed to respond to the fact that the $1.40 level remained intact and that Draghi tried keeping the market fearful of bold action next month when new staff forecasts will be available. The euro is technically posting a key reversal, and needs to close below yesterday’s low around $1.3910 to confirm it. The Euribor futures strip has rallied. However, if inflation expectations are indeed firmly anchored, then unconventional action, and especially, what we have called nuclear options of asset purchases or a negative deposit rate, seem less likely. 

Reading between the lines, it appears that even if Draghi himself wanted to ease policy, he is institutionally constrained by the need for consensus. Several of the creditor countries, led by Germany, are more worried about interest rates being too low for too long then the lowflation. Note that as the euro area expands, the ECB is going to adopt a rotating voting basis, and this will add a new wrinkle into ECB meetings next year. 

Draghi also seemed to unnecessarily emphasis geopolitical risks as influencing capital inflows into the euro area. This seems to be a bit of a stretch. It is not clear that a more aggressive Russia is a compelling argument to buy Portugal, Greek, let alone Spanish and Italian bonds. Draghi’s comments have not only rallied the short-end (Euribor), but Italian and Spanish 10-year bond yields are at new lows. 

Draghi makes no mention of the euro area current account surplus and that the diminished risk of redenomination and default risk makes the peripheral bonds attractive, regardless of Russia’s actions. Nor does he warn, as officials have done, when credit spreads were last this low, that the markets are misprinting risk. The IMF has warned along these lines, but Draghi and the ECB are silent on the issue.