European Central Bank President Mario Draghi is putting his reputation on the line by talking up the prospects of additional stimulus for the eurozone, less than two months after he disappointed investors with a smaller-than-expected package of measures, analysts said.
In speeches over the past week, Mr. Draghi has doubled down on his unexpected pledge at last week’s news conference to “review and possibly reconsider” the bank’s ?1.5 trillion ($1.63 trillion) stimulus program in March.
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 9-month low, indicating investors expect more bond purchases.
Falling short again would likely undermine Mr. Draghi’s ability to soothe markets with his words, analysts said?a linchpin of the ECB’s crisis strategy.
Mr. Draghi’s aggressive stance echoes the buildup to the ECB’s December policy meeting, whose outcome hammered U.S. and European stocks and drove up the euro against the dollar.
Mr. Draghi had indicated at the preceding meeting in October that the stimulus would “need to be re-examined” at the following meeting, and subsequently underlined the bank’s resolve to “do what we must to raise” persistently low inflation in the eurozone.
In December, investors and economists concluded that the bank’s decision to expand its bond-purchase program and cut an already negative deposit rate to encourage lending was insufficient, given heightened expectations for more aggressive action.
Satisfying market expectations this time will be tough, analysts said, particularly because the ECB’s 25-strong governing council isn’t as united on the need for additional stimulus as Mr. Draghi has suggested, according to people familiar with the matter. Some economists also question whether the ECB is running out of tools to ramp up inflation after years of crisis measures.
“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.”
The ECB doesn’t aim to meet investors’ expectations but they do matter because they affect euro exchange rates and interest rates, which in turn impact eurozone exports, business investment and growth.
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.
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.”
Mr. Draghi has said recently he’s worried that a sharp drop in oil prices and headwinds from financial and commodity markets could entrench ultralow inflation in the eurozone.
“We are doing whatever is necessary to comply with our mandate, and we are not surrendering in front of these global factors,” Mr. Draghi said at last week’s news conference.
To satisfy investors, the ECB would need to significantly expand its bond purchases, Mr. Perkins said?either by increasing the ?60 billion it now buys each month—or by making the program indefinite, rather than expiring in March 2017, as now planned.
According to a Reuters poll published Wednesday, around 87% of economists expect the ECB to cut interest rates in March, and they see a 50:50 chance that the bank will also boost its asset purchases.
Mr. Draghi stressed last Thursday that the entire council had supported the decision to “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” it is still open to debate, according to people familiar with the matter. That likely means there is no unanimity on more stimulus in March, the people said.
While Mr. Draghi would only need a majority of his colleagues to support fresh stimulus, going against the wishes of powerful members such as Germany’s 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.
Mr. Draghi appears confident. In Switzerland on Friday, he said the ECB had “plenty of instruments” with which to drive up stubbornly low inflation, as well as the “determination and the willingness and the capacity” to act.
According to the Reuters poll, only 53% of economists agreed that Mr. Draghi had plenty of tools at his disposal. The remaining 47% didn’t.
“In the short term, the ECB certainly doesn’t have the tools to shock inflation back up,” said Christian Schulz, an economist with Citi in London. Still, it has “a long list of tools” available that could still be “quite powerful,” including further cuts to the deposit rate, expanding the bank’s asset purchases and changing the parameters that restrict the bonds it can buy, Mr. Schulz said.
Another concern is that while the ECB may be reaching the limits of what its stimulus tools can achieve their unintended consequences are growing. .
“The side effects of this medicine, the longer it has been applied, are becoming stronger and stronger, and the curative effects of this medication [are] becoming weaker and weaker,” Axel Weber, the former Bundesbank president and current chairman of UBS Group AG, told an audience at the World Economic Forum in Davos on Friday.
Similar concerns were expressed at the ECB’s December meeting, according to minutes it published earlier this month. Some council members warned of “significant risks and side effects” associated with more government bond purchases, a tool that 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. Cutting that rate below minus 0.3%, where it currently stands, might lead “to a tightening instead of a further easing in financial condition,” as banks seek to recoup their losses on deposits by increasing loan rates?precisely the opposite of what the ECB wants to achieve.