The above picture represents how the to-do list of Mario Draghi, the European Central Bank (ECB) governor, might have looked when he attended the bank’s monetary policy review meeting and press conference later on March 6.
Because that’s what we got. A “do nothing” stance.
Some action had been widely expected, especially since Mario Draghi, the ECB’s governor, keeps repeating that the bank stands “ready to act” to maintain price stability, the central bank’s top mandate.
However, it’s becoming increasingly clear that, Draghi is hoping to puff the eurozone ahead solely on the strength of his words.
Why is that? Here are what I believe are the five takeways from Thursday’s performance:
One, the ECB is reconciled to low inflation in the eurozone for the next few years — and is content not to do anything about it.
According to the bank’s own forecasts until 2016, inflation in the 18-currency eurozone isn’t expected to come close to the bank’s preferred “close to 2%” target. Inflation is estimated at 1% in 2014, 1.3% in 2015 and 1.6% in 2016.
That suggests the ECB is unlikely to act unless something significant or material happens to alter those forecasts.
That approach doesn’t sit very well with some experts. As a recent policy brief by Angel Ubide of the Peterson Institute for International Economics notes: “By accepting a long period of low inflation, the ECB is either revealing a new, deflationary bias or not fulfilling its price stability mandate.”
Two, the ECB is currently focused on talking up the growth signs in the eurozone. It’s probably hoping that will be enough and there won’t be need for further action.
While most external experts and observers have been clamouring for the central bank to do something to fend of the threat of deflation, Draghi has been focusing on the positive aspects of the eurozone economy.
Indeed, on Thursday, Draghi described the eurozone as “an island of stability,” while outlining reasons why the currency bloc was unlikely to fall into a deflationary trap as Japan.
So, even though Draghi keeps saying the central bank is “ready to act”, the reality is that for now, action of any sort is not on the ECB’s agenda.
That “steady state,” so to speak, might be because of reason number three: the ECB’s crisis-fighting tools are quite limited.
As a must-read Forbes article highlights, there are just five (mostly ineffective) options on the table:
one, cut the main policy rate, already at 0.25%, even further (an ineffective, token gesture);
two, offer offer funding for lending to the real economy (but demand for funds just isn’t there from the private sector and banks might not be eager to push up risky lending);
three, cut the rate on commercial bank deposits with the central bank to zero (debatable effect on inflation or growth);
four, purchase packages of loans to businesses a.k.a asset-backed securities (but the small market in Europe will lead to limited impact);
and five; announce quantitative easing (which is fraught with legal challenges, in particular, from Germany).
The ECB is possibly hoping it doesn’t have to use any of these instruments any time soon, and that talk will be enough to push the eurozone away from any deflationary threat.
Four, the ECB is possibly hoping that supervisory action might be a more efficient tool than monetary policy.
The ECB is in the process of assessing the balance sheets of the eurozone’s 130 largest banks as it readies to assume the role of the region’s banking regulator later this year.
The Asset Quality Review is aimed at ensuring that banks accurately identify bad loans, and take appropriate protective measures, such as raising capital and/or increasing risk provisions.
Currently, funding costs differ widely for countries in the eurozone as country-specific risks came to the fore in the aftermath of the region’s sovereign debt crisis of 2009-10, as a Reuters report shows. That means the impact of an ultra-low ECB policy rate doesn’t filter evenly among all nations of the currency bloc.
For banks in the troubled peripheral countries, passing the AQR could help lower their perceived risk levels, which could translate to lower interest rates, and “would amount to a substantial monetary policy stimulus for the periphery and is therefore inherently also a monetary policy event,” according to a commentary by the Peterson Institute of International Economics.
Supervisory and macro-prudential regulation, rather than another rate cut, could, possibly do more for boosting economic activity and prices in peripheral countries (where the threat of deflation is greatest).
Five, the ECB might be keeping its options open in case things threaten to escalate out of control in the eurozone again.
To be fair, nothing in the region’s economic indicators screams ‘crisis’ as of now. But if the ECB uses up whatever little monetary ammunition it has left, it may be hamstrung when another crisis strikes.
And that, ladies and gentlemen, sums up what lies behind the ECB’s wisdom of doing nothing.