ECB President Mario Draghi, speaking at Sintra, has raised expectations of renewed policy easing. The message from the FOMC meeting is that rate cuts are coming. This policy synchronisation reflects shared issues (inflation too low versus target) and shared concerns, the major being rising uncertainty. Should this continue, the effectiveness of monetary accomodation will suffer.
One single striking statement is like a one-off event, two may be the start of a tradition. At the ECB’s annual gathering in Sintra (Portugal), Mario Draghi created a surprise in 2017 by stating that as “the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged.”[i]
His speech this week was again headline-grabbing by evoking in not to be mistaken words the likelihood of more policy easing. “The risk outlook remains tilted to the downside, and indicators for the coming quarters point to lingering softness… In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.”[ii] The policy implications will be discussed in the Governing Council in the coming weeks, which suggests that more accommodation can come sooner rather than later. In terms of toolkit, he mentioned forward guidance can be adjusted in terms of bias and conditionality. This means that the ECB could state that rates will stay at the current level or lower until a date which stretches further into the future. Additional interest rate cuts are possible with “mitigating measures to contain any side effects remain part of our tools” (this hints at a tiering of the deposit rate)[iii].
The most important sentence of the speech was that “the Treaty requires that our actions are both necessary and proportionate to fulfil our mandate and achieve our objective, which implies that the limits we establish on our tools are specific to the contingencies we face.” To put it differently, the limits of the asset purchase programme will be adapted in line with the urgency of the situation. As shown in the charts, Bund yields dropped and pulled along US treasury yields, European equity prices increased, the euro weakened and the 5 year in 5 year inflation swap increased as well, which means slightly higher inflation expectations and/or inflation risk premium. This comes as a relief given its significant decline in recent weeks.
One interpretation why the ECB President went much further than during his press conference two weeks earlier is that the tone at the Fed’s meeting the following day was expected to shift. A more dovish message from the ECB could pre-empt an appreciation of the euro if the Fed would hint at policy easing[iv].
