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Analysis
Draghi facing problems over quantitative easing

Draghi facing problems over quantitative easing

ECB president may have cause to thank Weidmann for blocking a counterproductive move 

by David Marsh

Mon 8 Dec 2014

As Oscar Wilde might have written had he been a follower of the European Central Bank, for Mario Draghi, the ECB president, to lose one board member’s support over quantitative easing may be regarded as a misfortune; to lose two looks like carelessness; to lose three might be downright embarrassing. 

On the key question of whether or not the ECB will embark on hefty government bond purchases, Draghi and the financial markets have been blowing smoke signals at each other for several months, playing with words, intentions, expectations and political and economic sensitivities.

Without taking any far-going decisions, Draghi has deftly achieved quite a number of his broad tactical objectives. He has brought down the value of the euro, lowered further the spreads between German and peripheral government bonds, and prevented a massive downturn on equity markets. 

The phrase ‘thought leadership’ is over-used – but Draghi has given it a new meaning: achieving results just by thinking about them.

Jens Weidmann, the Bundesbank president, is much denigrated, both in the conservative professorial hinterland of Germany where he is widely mocked for being ‘too soft’, and in other parts of Europe for being an obdurately retrograde hawk determined to drive Europe into the deflationary dust.

In fact he seems to be doing a good job of blocking (alongside others, including members of the ECB's six-strong executive board) a further string of unconventional measures which are probably unnecessary, might well be counterproductive and could easily reverberate badly on the ECB and its reputation.

In coming years, Draghi might have cause to thank Weidmann for protecting him from embarking on a path which would have badly dented his image as a policy-maker who gets his way with cleverly-spun words rather than risky actions that might backfire.

Of course, Draghi has failed so far in his strategic goal of restoring inflation to the ECB’s medium-term target of close to though below 2%. And the euro area, as has long been evident, is mired in stagnation. But arguably both of these shortcomings have little to do with the direction and conduct of monetary policy.

I still believe that full-scale QE will probably not take place and that Draghi’s statements on restoring the size of the ECB’s balance sheet to the ‘dimensions’ of early 2012 will go down in history as yet another set of relatively forgettable central bankers’ remarks that failed to become reality.

Much has been made of Draghi’s shift in wording on 4 December towards the targeted balance sheet expansion being ‘intended’ rather than ‘expected’. A moment’s reflection shows that this does not necessarily imply a higher probability that the goal will actually be achieved. A military leader facing widening odds may well intend to win the war, but his – and his adversaries’ – expectations may weaken as battles continue and defeats pile up. That seems to sum up Draghi’s position right now.

Neither the monetary policy meeting on 22 January nor the one after that – in Cyprus on 5 March – seems likely to produce the landmark move for which many in the markets have been waiting. On the latter occasion, it would be unpropitious, to say the least, for the ECB to cross the Rubicon in a place rescued from bankruptcy only two years ago, which still maintains currency controls among its scar tissues.

If Weidmann and his allies, through a mixture of threats, blandishments, subterfuge and propaganda, can hold off the proponents of full-scale QE until next spring-summer, the game may be over. US interest rates will be well on the rise, the US recovery will be more secure, the euro will be a lot weaker and the oil price will have started to recover. We will start to see growth and a moderate uptick in inflation in Europe – and the somewhat nonsensical panic-mongering in Europe over allegedly disastrous falls in inflation will be a thing of the past.

I would remind readers of what I wrote in mid-June: ‘The euro area’s hawks – led by Weidmann and Nederlandsche Bank President Klaas Knot – achieved their goal... Many market participants believe that full-scale QE through ECB purchases of government bonds may soon come under ECB consideration. However part of the compromise is that, whatever the short-term outlook for growth and inflation, ECB government-bond purchases are now effectively off the agenda at least until the first few months of next year. With US interest rates expected to rise from the end of the year onwards, the Bundesbank and other leading European central banks will be very cautious about US-European monetary decoupling and will step up their lobbying against any kind of government-bond operations. Given Draghi’s own conservative instincts on this issue, government-bond purchases in Europe (including enactment of the OMTs) are now extremely unlikely.’

That remains my assessment now

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