Draghi’s Divided ECB Leaves Markets Hoping for Government Action

(Bloomberg) --

Mario Draghi is leaving the European Central Bank with a final stimulus package that has divided colleagues and drawn doubts over its economic effectiveness, putting governments under renewed pressure to step up with fiscal policy.

His successor Christine Lagarde will inherit the presidency on Nov. 1 unsure how much more the institution can do to revive growth and inflation. Not only did Draghi’s plan to resume bond purchases and cut interest rates further below zero face unprecedented opposition in the Governing Council, but investors and economists aren’t sure it’ll work.

“They’re taking a hell of a risk with financial stability,” said Anatoli Annenkov, senior economist at Societe Generale in London. “It’s locking Lagarde into a situation where she has to talk to finance ministers every day. The problem now is that markets will start asking ‘will fiscal policy act?’”

The ECB cut the deposit rate to a record-low minus 0.5% and said it’ll buy 20 billion euros ($22 billion) a month of debt for as long as needed. Rates won’t be raised until inflation is “robustly” in line with its goal of just under 2%.

The euro rose for a second day on Friday.

The size of the QE program was a “disappointment,” as was “the fact that Draghi was quite explicit about the downsides of negative rates,” said Antoine Bouvet, a senior rates strategist at ING Bank NV. “This may be the start of a departure away from the bazooka approach that has caused so much controversy.”

The bazooka -- powerful measures, sometimes unconventional -- has been a hallmark of Draghi’s eight-year term as he fought off first a European debt crisis and then the economy’s stumble toward deflation.

“We are hoping that the package that was agreed yesterday would re-anchor inflation expectations closer to our target in the coming forecasting rounds,” Latvian central-bank governor Ilmars Rimsevics said in a Bloomberg interview. He discounted concerns that the ECB could run out of government bonds to buy, arguing “there are still plenty of them around.”

The task of convincing skeptical colleagues has become harder though. Thursday’s fractious meeting saw an unprecedented revolt in which Bank of France Governor Francois Villeroy de Galhau joined more traditional hawks including his Dutch colleague Klaas Knot and Bundesbank President Jens Weidmann to oppose QE.

Austria’s Robert Holzmann said there were doubts about the effectiveness of the actions.

“It was about the question, ‘How effective will a further monetary easing in various areas be?”’ he said in a separate Bloomberg Television interview on Friday. “This was a major reason why a pushback took place.”

That could make Lagarde’s room for large measures harder, despite her pledge in a European Parliament hearing this month to act with “agility” in restoring inflation.

Another issue is that there’s scant evidence that Draghi’s measures have worked. While the ECB argues that things would have been far worse had it not pumped so much stimulus into the economy in past years, updated forecasts on Thursday showed the central bank sees inflation at just 1% next year and 1.5% in 2021, well short of the institution’s goal and a sign the new stimulus will run for a while. Economic growth projections were also downgraded.

What Bloomberg Economics Says

“The ECB’s forecasts suggest it sees underlying inflation rising considerably in 2021, meaning another two years of asset purchases are likely.”

--David Powell and Jamie Rush
Click here for the full report

For economists, the signal is that the ECB is near its limit. Draghi himself coupled the new monetary measures with an aggressive call on governments to join his efforts to support the economy. He said it is “high time for fiscal policy to take charge.”

Whether governments will heed the call he’s made for years -- albeit in softer tones -- remains open. Germany, with a budget surplus and rapidly declining debt burden, said this week that it’s sticking to its balanced budget. Chancellor Angela Merkel said there are plenty of investment projects already in the pipeline.

All the ECB might be able to do now is make the funding of such projects as cheap as possible.

“The impact of further easing on business and household spending is likely to be very small,” Florian Hense, an economist at Berenberg, said in a note. “By lowering funding costs further, it can make it easier for governments to finance a modest fiscal expansion and nudge countries with some extra fiscal space to actually use it – think Germany.”

--With assistance from Anooja Debnath, Yuko Takeo, Jill Ward, Zoe Schneeweiss, Boris Groendahl, Alessandro Speciale and Maria Tadeo.

To contact the reporters on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net;Jana Randow in Frankfurt at jrandow@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Brian Swint

©2019 Bloomberg L.P.