Mario Draghi, president of the European Central Bank (ECB.) (Photographer: Peti Kollanyi/Bloomberg)

Draghi Sees Room for Paring Stimulus Without Tightening Policy

(Bloomberg) -- Mario Draghi hinted at how he may sell a gradual unwinding of European Central Bank stimulus.

The ECB president repeated his mantra that the Governing Council needs to be patient in letting inflation pressures build in the euro area and prudent in withdrawing support. At the same time, there’s room to tweak existing measures.

“As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged.”

The comments echo an argument first made by Bundesbank President Jens Weidmann as early as November that, all else being equal, ECB policy would become more accommodative as inflation picked up. With his nod to a frequent critic of quantitative easing who has been calling for an end of the 2.3 trillion-euro ($2.6 trillion) program, Draghi may have set the stage for a discussion in the coming months on phasing out asset purchases. They are currently scheduled to run until the end of the year.

“Draghi moved his first step toward indicating that ECB monetary policy will become less accommodative in 2018,” Marco Valli, an economist at UniCredit in Milan, wrote in a client note. “Unless an unexpected shock materializes, a formal tapering announcement is likely to come at the ECB monetary-policy meeting scheduled on 7 September.”

The euro rose by the most in two weeks as markets took Draghi’s remarks as a sign that an exit may be closer than anticipated.

The 69-year-old Italian started his speech at the ECB’s annual conference in Sintra, Portugal, with acknowledging the improving prospects of the 19-nation region and the key role played by monetary policy in fostering the upturn. He then went on to examine why stronger growth isn’t translating into faster inflation, a puzzle faced by central bankers around the world.

Weak oil prices are partly to blame, Draghi said, but in contrast to a similar plunge two years ago, he stressed that this time, policy makers can afford to wait for the energy effects to wear out.

“Our analysis suggests that the drivers of low oil prices at present are mainly supply factors, which a central bank can typically look through. And even if supply factors affect the path of inflation for some time, with inflation expectations secure, they should not ultimately affect the inflation trend.”

Sluggish wage growth is another factor keeping prices down. Draghi argued there are reasons to believe the financial crisis changed compensation and price-setting behavior in the euro area. 

Deflation though, the ECB president reiterated, is now off the table. Monetary policy is effective and “reflationary forces” are working their way through the economy, he said, paving the way for normalization -- with one caveat.

“In the current context where global uncertainties remain elevated, there are strong grounds for prudence in the adjustment of monetary-policy parameters, even when accompanying the recovery,” he said. “Any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure.”