European Central Bank President Mario Draghi over the past week has repeatedly talked up the prospects of additional stimulus for the eurozone, doubling down on his unexpected pledge to review the bank’s EUR1.5 trillion ($1.63 trillion) stimulus program in March.
Potentially complicating his efforts: The members of the ECB’s governing council aren’t as united on the course of action as he may want the world to think, people familiar with the matter said.
Mr. Draghi is putting his reputation on the line with his renewed focus on increased stimulus less than two months after the bank disappointed investors with a smaller-than-expected package of measures, analysts said. Investors are anticipating something big. Yields on German five-year government bonds edged to successive record lows of around minus 0.25% this week, while 10-year yields fell close to a nine-month low, indicating investors expect more bond purchases.
The ECB president had never really disappointed markets before December, said Dario Perkins, an economist at Lombard Street Research in London. “He has to do something in March, and it has to be significant. If not, he will have a real credibility problem.”
The ECB president stressed in his news conference last Thursday that the entire 25-member council had supported a decision to “review and possibly reconsider” the bank’s stimulus in March.
But while the council was unanimous on the need to review the bank’s stimulus, whether they will reconsider its size is still open to debate, according to people familiar with the matter. That likely means there isn’t unanimity on increasing stimulus in March, the people said.
In Bonn on Thursday, Jens Weidmann, the head of Deutsche Bundesbank, warned that the ECB should look through what he described as a “short-term, oil-price driven” drop in consumer prices as it decides whether to boost its stimulus program.
After stripping out volatile energy and food prices, so-called core inflation in the euro area is rising and “far from the deflation danger zone,” said Mr. Weidmann, who sits on the ECB’s governing council.
Unanimity isn’t needed to launch fresh stimulus, rather only a majority vote of the council. However, going against the wishes of powerful members such as the Bundesbank poses risks for the ECB, even if it has happened before, analysts said. The Bundesbank opposed the ECB’s decision to launch bond purchases last year, and the program’s expansion in December. Alienating Germany’s central bank raises longer-term questions about the ECB’s credibility because Germany represents more than a quarter of the eurozone’s economy.
“I don’t think [Mr. Draghi] is able to deliver,” said Carsten Brzeski, an economist with ING in Frankfurt. “I think he’s on the way to making the same mistake he made in October.”
Mr. Draghi had indicated at the meeting in October that the bank’s stimulus would need to be re-examined, and subsequently underlined the bank’s resolve to “do what we must to raise” persistently low inflation in the eurozone.
The bank’s December move to extend its bond purchases by six months through March 2017 and cut an already negative deposit rate by 0.1 percentage point to minus 0.3% failed to meet investors’ expectations, hammering stocks and driving up the euro against the dollar. A repeat would likely undermine the ECB president’s ability to soothe markets with his words, analysts said–a linchpin of the ECB’s crisis strategy.
It was Mr. Draghi’s pledge in July 2012 to do “whatever it takes” to save the currency union that helped draw a line under the region’s sovereign-debt crisis.
Mr. Draghi is taking a confident stance. In Switzerland on Friday, he said the ECB had “plenty of instruments” to drive up stubbornly low inflation, as well as the “determination and the willingness and the capacity” to act. Eurozone inflation was 0.2% in December, and the ECB expects it to remain very low or negative over the coming months, far off the bank’s target rate of just below 2%.
At exchange group Deutsche Börse AG on Monday, Mr. Draghi took the fight to his critics in Germany, listing and dismissing a series of common German arguments against keeping interest rates ultralow.
A sharp drop in oil prices and headwinds from financial and commodity markets could entrench ultralow inflation in the eurozone, Mr. Draghi said at last week’s news conference. “We are doing whatever is necessary to comply with our mandate, and we are not surrendering in front of these global factors,” he said.
Mr. Weidmann on Thursday conceded that downward pressures on consumer prices had increased, and that the ECB would likely need to “substantially” lower its inflation forecast for 2016.
But he warned against fixating on current price movements.
“In estimating risks to prices, we shouldn’t stare at current consumer price inflation rates like a rabbit at a snake,” Mr. Weidmann said.
To satisfy investors, the ECB would need to significantly expand its bond purchases, Mr. Perkins of Lombard Street Research said–either by increasing the EUR60 billion it now buys each month or by making the program indefinite.
A number of bank economists said they now expect the ECB to announce additional stimulus in March rather than June. Berenberg, J.P. Morgan and Royal Bank of Scotland all expect the ECB to increase its monthly bond purchases by at least EUR10 billion from EUR60 billion currently, and to cut its deposit rate by at least a further 0.1 percentage point.
Another concern is that while the ECB may be reaching the limits of what its stimulus tools can achieve, their unintended consequences are growing.
At the ECB’s December meeting, according to minutes published earlier this month, some council members warned of “significant risks and side effects” associated with more government-bond purchases–a tool they argued should be kept in reserve in case of very adverse developments, such as deflation.
Some members also warned against a further cut to the ECB’s deposit rate, the interest on funds stored overnight with the central bank. That could lead “to a tightening instead of a further easing,” as banks seek to recoup their losses on deposits by increasing loan rates–precisely the opposite of what the ECB wants to achieve.