Let’s See How Mario Draghi Digs Himself Out of This Hole
Mario Draghi, president of the European Central Bank (ECB), pauses during a news conference following the bank’s interest rate decision, at the ECB headquarters in Frankfurt, Germany. (Photographer: Alex Kraus/Bloomberg)

Let’s See How Mario Draghi Digs Himself Out of This Hole

(Bloomberg Gadfly) -- European Central Bank President Mario Draghi has some explaining to do on Thursday. 

At the press conference following the Dec. 14 policy decision, he was asked if officials discussed severing the link between guidance on the Asset Purchase Program and inflation, so that policy on future bond purchases wouldn't depend on the outlook for price gains. This is how he responded:

"...we didn't discuss cutting the link. That was not discussed."

Which is curious, given that minutes of the policy meeting, published Jan. 11 in the bank's characteristically convoluted prose, said:

"...it was seen as warranted to reflect on how to transition gradually from the present conditionality focused on APP net purchases to a broader concept of forward guidance comprising various dimensions of the monetary policy stance."

Translating the ECB speak, by "present conditionality" the minutes mean "conditional on inflation."

So, they did discuss it, then. 

There's more to this than the president of the central bank looking like he's being economical with the truth. 

The big question for investors is when quantitative easing will end. Already the euro and European bond yields are climbing higher on speculation that this will happen, for real, when the current program expires in September. 

Let’s See How Mario Draghi Digs Himself Out of This Hole

It's not easy to see how the ECB gets there given that it has no great expectations for faster inflation. But a debate on the 25-member council has sprung up around separating the link between QE and progress on prices. By disconnecting the two, bond buying could be ended at the ECB's discretion rather than being solely data dependent.

Were officials to sever that link, or even make progress in the debate on cutting it, markets would react. Ten-year bund yields could break the 60 basis point ceiling that capped its 2017 range. The euro could extend its year-long rally up to the $1.25 level last seen three years ago.

Let’s See How Mario Draghi Digs Himself Out of This Hole

The question is if, or how, Draghi admits at the Jan. 24 press conference that he (at best) made a mistake in December, that the debate on inflation and QE is live, and how that squares that with any update on forward guidance. According to the December minutes, the "widely shared" view was that guidance should be revisited early this year. While normally that would mean the March 8 decision, since that's when officials will have updated growth and inflation projections, Draghi's refusal to recognize a genuine debate on his own committee may force his hand.

The latest Bloomberg News survey shows how market expectations for when the bank will announce the end of QE are already shifting -- largely a result of the hardening rhetoric from senior ECB members such as Jens Weidmann and Benoit Coeure.

Let’s See How Mario Draghi Digs Himself Out of This Hole

And a look at how the euro reacted to the publication of the minutes shows that investors are prepared to ignore Draghi's assessment of the governing council's thinking. With growing signs of economic recovery, deteriorating investor faith in his guidance could have a more profound effects on markets than the actual measures taken to end QE. 

Let’s See How Mario Draghi Digs Himself Out of This Hole

Draghi may yet manage this. He's normally a master at communication and keeping the committee in tune with his leadership. After all, the other two elements of forward guidance, keeping rates on hold and re-investing maturing bond purchases, are fully backed by all members. 

Acknowledging the tide is shifting is part of maintaining control -- and that can keep a lid on both the euro and bund yields.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

To contact the author of this story: Marcus Ashworth in London at mashworth4@bloomberg.net.

©2018 Bloomberg L.P.

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