European Central Bank President Mario Draghi said he can’t exclude the risk of deflation in the euro area, in a sign that the likelihood of large-scale quantitative easing is increasing.
“The risk that we don’t fulfill our mandate of price stability is higher than it was six months ago,” Draghi said in an interview with German newspaper Handelsblatt. “We are in technical preparations to alter the size, speed and composition of our measures at the beginning of 2015, should this become necessary, to react to a too-long period of low inflation. There’s unanimity in the ECB council on that.”
Draghi rarely gives media interviews and his comments reflect a drive to win over critics of QE in Germany, the euro area’s largest economy. The debate over whether fresh stimulus is needed has reopened a rift on the Governing Council, with Bundesbank President Jens Weidmann arguing that more stimulus is currently unwarranted while others warn too-low inflation expectations could become entrenched.
“Those traditional hawks who had wanted to stick to standard monetary-policy instruments in the wake of the worst financial crisis in 80 years have been proven wrong and wrong again,” said Holger Schmieding, chief economist at Berenberg Bank in London. “Instead of inflation and moral hazard as the feared result of some non-standard policies, the eurozone is getting ever closer to deflation.”
The global economy ended 2014 in a fragile state as factories struggled to maintain growth across Europe and Asia, business surveys showed Thursday, adding to pressure on central banks to implement more stimulus.
Ebbing price pressures across the continents offers room for the People’s Bank of China and the European Central Bank to do more to drive up inflation and support growth.
“Growth really does appear to be stalling based on these indicators so certainly the pressure is on, although we are less worried about China,” said James Knightley, senior global economist at ING.
Euro zone manufacturing concluded last year on a subdued note as output, new orders and employment all recorded sluggish growth. Also of concern to policymakers, activity was weak in Germany, Europe’s largest economy, while the downturn also deepened in France, the euro bloc’s second-biggest.
Markit’s final December manufacturing Purchasing Managers’ Index stood at 50.6, down from an earlier flash reading of 50.8 but beating November’s 17-month low of 50.1.
That is above the 50 mark that separates growth from contraction, but there was little sign of any improvement this month, with the subindex for new orders at just 50.2, leading factories to barely increase headcount in December.
Yield Decline
Italian and Spanish bond yields dropped to record lows on Draghi’s comments and the euro fell to the weakest in four years. The single currency was down 0.5 per cent at $1.2048 at 10:31 a.m. Frankfurt time. The yield on 10-year Spanish government debt slid 8 basis points to 1.53 per cent.
The 25-member Governing Council will review a QE package at its next monetary-policy meeting on Jan. 22. An interim meeting will be held on Jan. 7 — the same day that euro-area inflation data are published. A Bloomberg survey shows consumer prices probably slid 0.1 per cent in December from a year earlier amid a slump in oil prices.
When asked about the probability of the region falling into deflation, or a spiral of declining prices that causes households to postpone spending, Draghi said “the risk cannot be entirely excluded, but it is limited,” and “we have to act against such risk.” Asked how much the ECB might spend on government bonds, he answered that “it’s difficult to say.”
Media Debate
The QE battle is being fought partly in the pages of German media. Peter Praet, the ECB’s chief economist, told Boersen- Zeitung this week that officials can’t look through the drop in oil prices as the risk of second-round effects is “higher than usual.” Vice President Vitor Constancio told WirtschaftsWoche last month that the ECB wants to prevent a “dangerous vicious circle of declining prices, rising real wage costs, falling profits, shrinking demand and further declining prices.”
Weidmann said in an interview with the Frankfurter Allgemeine Sonntagszeitung newspaper on Dec. 28 that cheaper oil is acting like an economic stimulus and there is no need to add monetary-policy measures on top. He also said the ECB mustn’t bow to market pressure to start government-bond purchases.
Draghi said in December that he’s confident a stimulus program can be designed to have consensus in the Governing Council, though unanimity isn’t necessary.
Risk-Sharing
One stumbling block is how to share the risk of buying the bonds of stressed nations, according to Governing Council member Klaas Knot.
“As long as Europe isn’t politically willing to share more risks within the eurozone, it’s not up to us to take such a decision ourselves via the back door,” the Dutch central-bank governor said in an interview with de Volkskrant newspaper this week.
In the Handelsblatt interview, which was published in German, Draghi said economic growth in the euro area will remain weak unless European governments press ahead with reforms.
“Important structural reforms — more flexible labor markets, less bureaucracy, lower taxes — are coming too slowly,” he said. “It is very clear that our monetary policy would be more effective if governments implemented structural reforms.”
Bloomberg.com
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