Draghi's goodbye gift: QE until 2026?
In an effort to stimulate the flagging eurozone economy, the European Central Bank (ECB) has decided to cut its deposit interest rate from -0.40% to -0.50%, along with restarting its quantitative easing (QE) programme.
€20 billion of purchases per month is slightly less than the consensus expectations. However, the promise to keep purchases going until interest rates are raised again (rather than having a set time limit) is more generous than markets had expected. According to the expectations of money markets for the next interest rate rise, this would mean QE until 2026!
Despite this, it appears that markets were disappointed with the policy action. German government bond yields are higher than before the meeting (prices down), while the euro is now up against the US dollar and sterling compared to yesterday’s close.
In his final monetary policy meeting, ECB President Mario Draghi cited downgrades to the staff growth and inflation forecasts as the key reason for the return to QE – just nine months after it was ended.
He blamed higher geopolitical risk and the US-China trade war. This is troublesome, as the use of interest rates and QE cannot possibly impact the outcome of US-China trade talks. Looser monetary policy could at the margin strengthen domestic demand to offset the weakness in external demand, but with the domestic economy growing in-line with trend, the ECB actions today will have a tiny positive impact at best.
Draghi rightly complained that the lack of fiscal loosening from governments has exacerbated the situation. But questions have to be asked as to whether the marginal benefit achieved from today’s actions is worth the damage done to the banking system along with the pensions system.
The change in the ECB’s forward guidance today is also significant. Interest rates will remain at their present level or lower until inflation has sustainably returned to close to, but below, the ECB’s 2% target. This suggests that a further cut is very possible, as we have in our baseline forecast. We expect the ECB to lower the deposit rate again to -0.60% in December.
Also, Draghi was evasive during the monetary policy press conference when questioned about the nature of QE purchases. This suggests that they have yet to decide on how they can successfully deliver €20 billion per month without running out of assets.
Moreover, the open-ended nature of the latest QE programme could have profound effects. Draghi is confident that the programme will return inflation to target, just not before 2021.
Draghi will forever be remembered for doing “whatever it takes to save the euro” during the sovereign debt crisis. And introducing non-standard monetary policy at the ECB, which most thought would not be politically tolerated. However, he will also be remembered by investors and savers for failing to lift interest rates during his tenure.
We will see if the new president Christine Lagarde fares any better, but one thing is certain, the path for looser policy has been set, and it will be followed for some time.
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