ECB Hidden Agenda: Weaker Euro
November 6, 2014
The ECB didn’t change its three interest rates. The refinancing rate of 0.05% has been flanked by a marginal lending rate of 0.3% and a deposit rate of -0.20%. Each was cut by 10 basis points in September.
Draghi’s main message, emphasized in his press conference, is that the ECB balance sheet will be expanding in the period ahead and will be doing so at the same time that the Fed’s balance sheet and others will be shrinking. The ECB needs to support growth and raise both actual and short-term expected inflation back closer to target, that is less than but close to 2.0%. A weaker euro would meet these objectives and is the most direct channel by which diverging balance sheet sizes might promote these goals in the near term. Hence, the hidden agenda of the three unconventional policy tools — LTROS, covered bond purchases and forthcoming purchases of ABSs — seems to be a weakening euro. It is the expectation of Governing Council members that their asset buying will grow the ECB balance sheet toward its March 2012 level, but if that path of growth does not materialize in the way assumed, they are also unanimous in being “committed to using additional unconventional instruments within its mandate.”
Draghi has gone to lengths not to confirm reported frictions within the Council and to differentiate the Ezone situation from those faced by other central banks that have resorted to unconventional policy measures. He did his best to allay concerns that the ECB may not be countering excessively low inflation forcefully enough without revealing any fresh measures. The new pledge to expand the balance sheet is an intermediate target. Ultimately, history will judge the ECB by how soon it manages to restore in-target inflation, whether it prevents a collapse of medium-term price expectations, and if a third regional recession can be avoided. For the record, the latest statement concedes that weakening growth momentum is occurring and predicts that CPI inflation “will remain around current low levels over the coming months, before increasing gradually during 2015 and 2016.” Had the ECB since “the beginning of 2012” done its job better, current circumstances would have been avoided that still find the euro above its lifetime average level against the dollar and inflation at only 0.4%. Draghi deserves credit for avoiding a break-up of the euro, reducing long-term interest rate spreads, and engineering a drop in the whole structure of long-term rates, but the fact that most private ECB-watchers have long criticized the ECB for not providing more stimulus than it did is a legitimate complaint that goes to the ideological intransigence of Bundesbank President Weidmann and other hawks on the Council.
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