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Thursday, 7 April 2016
[B]— Draghi’s morphing into Harry Potter
By: Ben Traynor. Editor, DAILY RECKONING
Back in the summer of 2012 there were fears the Eurozone was on the verge of break-up.
Investors shunned the sovereign debt of the so-called periphery, causing government bond yields in Italy, Spain and elsewhere to spike to unsustainable levels.
That’s when European Central Bank president Mario Draghi made his famous “whatever it takes” speech.
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” the ECB chief tub-thumped.
“And believe me, it will be enough.”
As we all know, it worked a charm. Fear began to subside. Bond yields fell back.
Is it just me, or are there some faintly desperate echoes of that 2012 posture in today’s ECB communications?
[B]----- Going toe-to-toe with an abstract concept
Exhibit A. In his foreword to the ECB’s annual report, published this morning, Draghi writes that “the ECB does not surrender to excessively low inflation”.
It brings to mind an image of a fighty man in a pub carpark shouting at consumer prices to “Get higher!”
Or maybe I’ve just been back in the north east too long…
Exhibit B comes from an interview given by ECB Executive Board member Peter Praet to an Italian newspaper.
The interview was actually published back on March 18, but it’s making headlines now after being given pride of place (in English) on the ECB’s homepage.
The headlines come from Praet’s insistence that the ECB has not necessarily finished cutting interest rates.
It’s not journalistic spin that caused this to be the main talking point, by the way. On the ECB’s own site the story is titled ‘Praet says rates can still go lower’.
This is at odds with comments Draghi made in his press conference on March 10, in which he suggested the ECB didn’t think it would be necessary to push rates down any more.
The ECB’s in a pickle. It wants to make reassuring noises that it’s not powerless. Hence it says it can still cut rates.
But interest rates below zero (which is where the ECB’s deposit rate now is) are painful for Europe’s banking sector. So it seeks to reassure that things won’t get worse.
A four-year-old can see the contradiction, so I won’t labour it here. But something’s gotta give.
Exhibit C comes from ECB vice president Vitor Constancio. Presenting today’s annual report to the European Parliament in Brussels, Constancio said the ECB “will continue to do whatever is needed to pursue its price stability objective”.
The ECB launched another stimulus programme last month as part of its efforts to support Eurozone growth and therefore get inflation back up to 2%.
It may work. But there’s a growing sense that the ECB, along with other central banks, has hit its straps.
“Whatever it takes” has become less a statement of intent than an incantation. A magic spell. Something Harry Potter might say (though as a grown-up with no desire to read books for kids, I’ve never read one).
In 2012, “whatever it takes” was allied to a credible, commonly understood policy option. Investors were selling government bonds. This was pushing their borrowing costs higher.
Yet everyone knew that, if it chose to, the central bank could buy as many bonds on the market as it wanted. The “whatever it takes” speech was a heavy hint that it might do exactly that.
It was a credible threat.
[B]----- Central bank credibility is being stretched[/B]
Today, it’s not taken as a given that central banks can stimulate the economy and push inflation higher. Otherwise, why haven’t they done so already? Why is this even an issue?
I’m not saying all this to pick on the ECB. The latest minutes from the US Fed, published yesterday, show policymakers there are also unsure.
Over in Japan, meanwhile, negative interest rates have been met by a stronger currency. This is viewed as a big slap in the face for the Bank of Japan.
Among the loudest voices saying central bankers can only do so much are the central bankers themselves.
They know credibility is key to successful monetary policy. They know they risk losing it the longer they fight battles they don’t win, like the current one against deflation.
It’s one thing to say “Never Surrender”. But if you have to keep saying that, it also means you haven’t won.
Until next time…