Draghi speaks louder during ECB’s press conference

The main challenge for the ECB in 2014 will be to adopt further nonconventional monetary policy tools in order to boost its balance sheet, alleviate upward pressure on the euro and reduce deflationary pressure.

As expected, nothing concrete was announced yesterday. Nevertheless, Mario Draghi hinted at some interesting points, but it required reading between the lines. During the press conference the ECB president emphasised the central bank’s forward guidance. On several occasions he referred to the current low level of inflation and the risk of seeing this situation last longer: ‘[The euro area] may experience a prolonged period of low inflation.’ As a result, Mr Draghi firmly reiterated the ECB Governing Council (GC)’s mantra: ‘[The GC] continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time.’

Cautious over economic recovery
The GC seems ready to consider a wide range of instruments to respond to ‘unwarranted tightening’ (i.e. upward interest rate contagion coming from the Fed’s tapering) or an unexpected deterioration in the inflation outlook (i.e. lower inflation), even though Mr Draghi refused to be more specific on the kind of instruments being considered. He insisted on the fragility of the economic recovery on several occasions. Asked if the euro area crisis was over, he said: ‘I’d be very cautious.’ An answer that sounded like a snub to José Manuel Barroso, who claimed victory on Wednesday! The ECB’s caution on the economic dynamic looks as though it will last for a while yet, as the GC expects the euro area to continue to record subdued growth in 2014 and 2015.

Draghi ‘symmetrical’
Mr Draghi also confirmed another important point. He reads the inflation mandate in a very ‘symmetrical’ way. This means that the GC will have to act decisively if inflation is too far away from 2%, regardless of whether it is above or below this figure. This is a strong argument in the difference of opinion with the Bundesbank. According to Mr Draghi’s readings, the ECB will be entitled to take action to fight against inflation if it is too low. However, as tools to fight low inflation when interest rates are already at their zero bounds are by nature unconventional, Mr Draghi is suggesting that non-orthodox monetary tools have to be accepted!

ECB’s action will be required in 2014!
Yesterday’s press conference confirmed several points in our scenario:

• Mr Draghi’s cautious tone on economic recovery would appear to endorse our scenario of subdued growth

• The ‘symmetrical’ interpretation of the inflation mandate could be interpreted as a first step towards adoption of further nonconventional tools given that

1. The shrinking ECB balance sheet will contribute to euro strength.

2. The firmness of the euro is adding deflationary pressure.

3. The Fed’s tapering increases the risk of higher interest rates.

This could result in contagion to Europe.

• These three forces may lead to weaker economic growth, a risk of deflation and ‘japanisation’. The main challenge for the ECB in 2014 will therefore be to decouple from the Fed by adopting further nonconventional monetary policy tools in order to:

– boost the ECB’s balance sheet;
– alleviate upward pressure on the euro;
– reduce deflationary pressure.



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