Let’s begin with the premise that ECB boss Mario Draghi did not intend for his bank’s policy decision last week to cause the markets to come unhinged. It is safe to assume that Mr. Draghi’s to-do list last Thursday did not include entries such as: “1. Collapse stocks and bonds; 2. Send euro on a rocket-shot, truly counterproductive, rally.” I think that is a reasonable starting point.
Therefore, when the Bund yield rose very sharply, up twenty basis points on the session in reaction to the ECB, and the euro shot up three percent by the end of the day and the DAX fell 3.5% in the first ten minutes of the post meeting press conference, I think we can be sure that the ECB president did not whisper under his breath some like: “oooooh baby! Aced that test; Who da Man?!?!?” That’s pretty unlikely
So What Happened?
Mr. Draghi seemed very dovish at the press conference following the October ECB policy meeting. “The Governing Council is willing and able to act by using all the instruments available within its mandate if warranted in order to maintain an appropriate degree of monetary accommodation. In particular, the Governing Council recalls that the asset purchase programme provides sufficient flexibility in terms of adjusting its size, composition and duration.” The ECB stood pat in October, but things were discussed and Mr. Draghi left little doubt that the door was left ajar for action to be taken at the next meeting in December.
The ECB boss persisted with the theme that more stimulus was the answer to the questions being posed by the Euro Zone economy. For instance, in a speech at the Frankfurt European Banking Congress on November 20, he catalogued the economy”s problems:
- “First, the downside risks to our baseline scenario for the euro area economy have increased in recent months due to the deterioration of the external environment…”
- “Second, even factoring in those headwinds, the strength of the underlying recovery is modest…”
- “Third, the recovery remains very protracted in historical perspective…this matters not just because of the lost output in that time. Such a prolonged downturn also inevitably impacts the way firms and social partners set wages and prices, and this will continue to affect the recovery of inflation.”
Draghi’s speech continued with this assessment; he commented that there was “subdued wage growth in the euro area, suggesting that the output gap is still exerting downward pressure on wages...” and that the “low core inflation is not something that we can be relaxed about, as it has in the past been a good forecaster for where inflation will stabilize in the medium term.” So, having said all that, Mr. Draghi summed it up:
“Putting the whole picture together, we have a situation where we cannot yet say with confidence that the process of economic repair in the euro area is complete…At our December Governing Council meeting, we will thoroughly assess the strength and persistence of the factors that are slowing the return of inflation towards 2%...If we conclude that the balance of risks to our medium-term price stability objective is skewed to the downside, we will act by using all the instruments available within our mandate. In particular, we consider the APP (Asset Purchase Programme) to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary policy stance…So let me reiterate what I said here last year: if we decide that the current trajectory of our policy is not sufficient to achieve that objective, we will do what we must to raise inflation as quickly as possible. That is what our price stability mandate requires of us.”
There were no guarantees of specific policy action in Draghi’s speech. But his description of the economy, the urgency of situation and the remedies that he envisioned, only served to reinforce the idea that the ECB would take decisive action in December. More accommodation, including an increase in the size of the QE package was a seed that was first planted during the post meeting press conference on October 22; demonstrated back then by the two percent decline in the value of the euro on that day.
So the stage was set and Draghi was not backing off any hint of easing that he had lain. Even in the face of opposition to easier policy from other Council members such as: Sabine Lautenschlager, Ardo Hansson and Jens Weidmann. Just one week before the December 3 policy meeting Weidmann, the Bundesbank President, downplayed the idea that more stimulus was necessary, at an event which the ECB boss was also attending. Draghi did not back off in the presence of the German banker; he said that policy makers “will do what we must to raise inflation as quickly as possible.”
Just a few days prior to the policy meeting a report from Bloomberg News described the market sentiment of the ECB. “Mario Draghi has no room to back down. Economists surveyed by Bloomberg unanimously predict the European Central Bank will boost stimulus again this week, less than halfway through a 1.1 trillion-euro ($1.2 trillion) bond-buying program, and most foresee multiple measures. The institution’s president must now find a way to meet expectations or risk an investor backlash that could stymie the euro-area recovery. Draghi has been priming markets for action since October, saying the ECB will do what it must to raise inflation as quickly as possible, and investors are betting that the probability of a deposit-rate cut is 100 percent. Now, even with some officials voicing misgivings, his Governing Council may find that only a rate reduction combined with increased bond purchases and possibly as-yet unannounced tools will prove convincing enough.”
Mario Draghi set the Bar High. The ECB Failed to Clear it.
It is not as though the ECB did nothing. They added accommodation by: lowering the deposit rate; extending the duration of the asset purchases; deciding to reinvest the principal payments: and widening the types of assets that they will buy. But it was not enough.
There was never a promise to expand the size of the purchase program, but it was suggested, more than once, and the idea was never walked back by Draghi. That the market was looking for an expanded APP was not a secret; reports such as the one from Bloomberg that is quoted above show that to be the case. But the ECB did not deliver and that was a very big surprise, really big; the markets hyper reaction says as much.
On the one hand maybe Draghi never bothered to count votes going into the meeting; if he had maybe he would not have spoken so confidently about the possible policy actions in the weeks leading up to the meeting. “Resistance will come from the governing council’s German contingent of Bundesbank president Jens Weidmann and ECB board member Sabine Lautenschlager, and the heads of the Estonian, Latvian and Slovenian central banks. ECB board member Yves Mersch and Governor of the Dutch central bank, Klaas could also object,” wrote the Financial Times the day before the meeting. “Complicating the ECB president’s task, these possible dissenters are all among the 21 council members that hold voting rights at this month’s meeting. A quirk of EU law means that voting limits have been in place since Lithuania joined the euro in January, pushing the number of central banks governors to 19. They are divided into two groups: five in the first group sharing four votes on a rotating basis and 14 in the second groups sharing 11 votes. The four abstainers this month—the governors of the French, Belgian, Finnish and Slovak central banks—are all likely supporters of Mr. Draghi.”
So the votes were stacked against him, but did Draghi even care about that?
But on the other hand it is more likely that Draghi never figured he would have to count votes, and this may be the more important point, if true.
Remember, Mario Draghi is the guy who ad-libbed a promise that the ECB will do “whatever it takes” to save the euro and then was able to follow up several weeks later with an ECB program designed to do just that. Surely Draghi had a solid handle on the sentiment of his colleagues back in the summer of 2012, but I doubt he sought their blessing before he went off text with his dramatic vow.
“The council seldom votes,” explained the Financial Times, “with meetings usually decided by Mr. Draghi’s wrap-up of the discussion and adjustment of the proposal in line with the consensus view.”
So I think that it is possible that Draghi went into the ECB meeting confident that despite the public opposition of some key council members, that he would be able to push through an aggressive easing that included an expansion of the size of the purchase program; just as he had suggested for the last six weeks he would do.
But Draghi was not able to get his way. He gave a curt response to the first question of the press conference that belied his satisfaction with the result. When asked if something had gone wrong with the communication process in the run up to the meeting and whether he had overestimated his ability to convince his fellow policy makers to do something more aggressive. “I don’t think our communication was wrong,” he said. Although I think that someone caught the wrong way in the collapsing stock and bond markets might see it differently.
Draghi described the ECB decisions as “adequate”; not exactly a rallying cry. “Come on mates, follow me, quickly as possible, do the minimum required. Be adequate!”
Well, the point is that if Draghi is no longer able to bend ECB policies to his way of thinking and the less accommodative policies favored by the Germans, et al, have a bigger influence on the future path for the bank, then maybe, all else being equal, the euro will catch a bid.
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