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Analysis
Shifting kaleidoscope of ECB power

Shifting kaleidoscope of ECB power

Another moment of truth
Bundesbank relishes new influence

by David Marsh

Mon 11 Mar 2013

A moment of truth is nearing for the European Central Bank and Mario Draghi, its president. In the 16 ½ months since the former Banca d'Italia governor became the dominant central banker for economic and monetary union (EMU), he has cut a supremely self-confident figure.

Draghi has revamped the ECB's communications, presided over a tighter, more effective board structure, guided plans for centralised ECB banking supervision and introduced two landmark moves to reinforce confidence in the euro. These are the long-term refinancing operations (LTRO) to aid bank lending, enacted in December 2011 and February 2012, and the outright monetary transactions (OMT) programme outlined in July 2012 and decided in September, a not-yet-used backstop measure for the ECB to purchase theoretically unlimited quantities of weaker euro member government bonds.

Maybe this was the easy part.

For all but the first two weeks of his mandate that started in November 2011, in the final days of the premiership of Silvio Berlusconi, Draghi has been ably assisted by the presence in Rome of Mario Monti's reformist technocratic government. Monti's high standing with the Germans, in particular his close relationship with Chancellor Angela Merkel, has substantially enhanced Draghi's own credibility in Germany, where politicians and the public are increasingly dubious about the euro's costs and benefits.

Draghi can draw on his personal record as a champion of stability and reform as former head of the Italian treasury and at the Italian central bank. Together with then ECB president Jean-Claude Trichet, Draghi played a crucial role in hastening Berlusconi's departure with their joint August 2011 letter to the then prime minister (written when Draghi was head of the Banca d'Italia) urging him to speed up reforms.

As ECB president, Draghi has withstood with aplomb the risks of occasional skirmishing (notably, on the OMT) with Jens Weidmann, the hawkish president of the German Bundesbank, which now appears to relish a return to something approaching its pre-EMU influence.

Now, the environment has subtly changed. Following the Italian elections two weeks ago which saw a comprehensive vote against Monti's austerity policies and a swing to anti-euro populists diversely led by former comedian Beppo Grillo as well as Berlusconi, the manoeuvring room of the ECB and Draghi himself has been curtailed.

Monti continues in office as caretaker while Pier Luigi Bersani, the centre-left leader, attempts to form what may be a minority government only weakly committed to reforms – an unstable equilibrium. New elections may be on the way. Whatever happens, Berlusconi, whether on the sidelines or close to centre stage, seems likely to wield influence that many earlier believed had disappeared for good.

The withdrawal of a reformist mandate in Rome has refashioned the complex, fluctuating three-way relationship between Draghi, Weidmann and Merkel (Weidmann's fomer boss during his previous post as her chief economic adviser). The focus has moved back towards promotion of Bundesbank-style orthodoxy.

At last week's monthly ECB press conference, Draghi declared that Ireland and other euro area countries subject to official rescue programmes must fully return to government bond markets before they could make use of OMT financing. He thus clarified in a manner satisfactory to the Bundesbank an ambiguity about the OMT that has persisted since the programme was unveiled in September last year.

The key to OMT is that countries applying for programmes must submit themselves to full European and International Monetary Fund conditionality. This stricture is unlikely to be fulfilled by any prospective Rome government. Draghi reiterated last week that Italy, like other countries in difficulties, 'should continue down the path of structural reforms, which is the only way to restore growth.’

There are indications that Draghi is reasserting the hawkish mood he displayed when he first moved to the ECB helm. On 3 November 2011, for example, at his first ECB press conference, he spoke out against the ECB 'becoming the lender of last resort for governments', saying: 'No, I do not think that this is really within the remit of the ECB. The remit of the ECB is maintaining price stability over the medium term.'

Against this background, the IMF has somewhat incautiously waded in, backing Ireland against the ECB on a future Dublin application to the OMT before regaining full access to markets. In a speech in Dublin Castle on Friday, Christine Lagarde, IMF managing director, said the programme could help reduce the financing costs of countries 'facing severe market constraints' and that countries 'on the right track' like Ireland deserved support to regain access.

Speaking a day after the ECB decided not to cut interest rates, Lagarde said the Fund believed the central bank still had 'some limited room' to cut further – another remark that will not endear her to key policy-makers in Frankfurt. In the shifting kaleidoscope of ECB power, Lagarde's remarks may not make an interest rate cut any more likely.

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