Draghi Seen Easing Policy by June as ECB Readies Rate Cut

10/4/2014

Mario Draghi will probably take action within two months against the threat of deflation, economists said.

Almost two-thirds of respondents in the Bloomberg Monthly Survey predicted the European Central Bank president will ease policy by June. Of those economists, just under half said he may implement multiple measures ranging from interest-rate cuts to asset purchases and long-term loans.

With euro-area inflation at the weakest in more than four years, Draghi says he has “unanimous” backing from policy makers for unconventional measures if needed. Even so, recent comments show officials haven’t yet agreed on which tools to use, setting them up for discussions on whether to take an unprecedented leap into quantitative easing or rely on smaller and more-targeted initiatives.

“The majority of ECB members doesn’t want to go down the large-scale asset-purchases route,” said Frederik Ducrozet, an economist at Credit Agricole CIB in Paris. “They’ll exhaust all the easier options they have before going to the bazooka of QE, and will see if they’re enough. And in the meantime, they’ll continue talking about QE.”

Draghi is fighting to combat weakness in price pressures that threatens to undermine the euro area’s recovery. Consumer prices in the 18-nation region climbed 0.5 percent in March from a year earlier, the slowest pace since October 2009 and well below the ECB’s goal of just under 2 percent.
Inflation Tolerance

Five of the 40 economists surveyed, or 13 percent, said the ECB will act on May 8 (EURR002W) in Brussels, at one of the two monetary-policy meetings each year that the central bank holds outside its Frankfurt headquarters, and 20 said measures will be announced the following month. Six economists said the decision-making Governing Council won’t ease policy further.

The survey also signaled that economists see the ECB’s tolerance for low inflation waning. About half said officials will look through further declines in the headline rate as long as core inflation holds or rises, down from 76 percent the previous month.

Draghi said after the April 3 meeting, when he left the benchmark interest rate at a record-low 0.25 percent, that the consumer-price gauge was distorted in March by one-time effects such as the timing of Easter and falling energy and food prices. Core inflation slowed to 0.8 percent that month from 1 percent in February.
QE Simulation

Draghi said policy makers had an “ample and rich discussion” that considered several options including a negative deposit rate and an asset-purchase program. The ECB has simulated buying 1 trillion euros ($1.4 trillion) of bonds to boost inflation, a person familiar with the matter told Bloomberg on April 4.

By holding off from any action until June, policy makers have a chance to see if price gains pick up as the economic recovery gathers speed. The International Monetary Fund raised its forecasts for the euro area this month, saying growth will be 1.2 percent in 2014 and 1.5 percent in 2015. It previously predicted expansions of 1.1 percent and 1.4 percent, respectively.

The ECB will release its own updated economic projections at the June meeting. Draghi said in April that officials needed more information to assess whether there has been a change in the medium-term outlook for inflation.
Economic Outlook

In the Bloomberg survey, 44 percent of respondents said the euro-area economy will improve over the next four weeks and 51 percent said it would stay broadly the same. Just 4 percent said it would deteriorate.

If action is required, economists are split on what it might be. Sixteen percent forecast a cut in the key interest rate and the same proportion foresees the purchase of asset-backed securities.

One in five said suspending the absorption of liquidity created by crisis-era bond purchases is likely, which would free up about 172 billion euros of cash. A similar number said the ECB will offer more long-term loans to banks as the 3-year loans extended in the depths of the financial crisis approach maturity.

“The ECB may cut interest rates in the coming months if euro-zone inflation slows and monetary conditions tighten,” said Tomas Holinka, an economist at Moody’s Analytics in Prague. “After the main refinancing rate stays close to zero, the ECB may unveil unconventional monetary tools such as quantitative easing and long-term refinancing operations.”
Next Steps

Policy makers haven’t shown themselves to be any more certain. Vice President Vitor Constancio said on April 7 that the ECB’s working groups are “considering many hypotheses.” Governing Council member Jens Weidmann said the same day that asset purchases need to meet distinct legal conditions, and his colleague Ewald Nowotny said he’d prefer to see measures to strengthen the market for asset-backed securities.

ECB officials including Executive Board members may elaborate on their thinking as they gather in Washington for the IMF’s Spring meetings. Constancio and chief economist Peter Praet are scheduled to make public appearances today, and Draghi and markets head Benoit Coeure will speak in coming days.

“One of the major reasons for the confusion, it seems to me, is that the ECB hasn’t finished their homework in terms of the impact of the various policy measures,” said Dermot O’Leary, chief economist at Goodbody Stockbrokers in Dublin. “They haven’t yet exhausted their conventional tools. I think that will be the first thing they will do and the obvious question the markets will ask, and journalists after the meeting, is what do you do next?”
Exchange Rate

Sixty percent of economists in the Bloomberg survey said the ECB may take steps to weaken the euro. While the exchange rate isn’t a policy target, Draghi has said he’s watching it “with attention.” The currency has gained almost 6 percent against the dollar in the past 12 months, depressing the price of imported goods and curbing the competitiveness of the currency bloc’s exporters.

Spanish Prime Minister Mariano Rajoy joined his French counterpart Manuel Valls yesterday in criticizing the ECB for not acting against the strong euro, which they say is hampering the euro-area economic recovery.

The central bank will try to prevent further gains if the euro rises to $1.40, according to the median of 19 estimates in the survey. The currency was little changed at $1.3854 at 9:11 a.m. Frankfurt time, after rising the past three days. Still, officials will stick to words rather than policy action, according to Sintje Boie, an analyst at HSH Nordbank AG in Hamburg.

“$1.40 could be a level where the ECB will get a little bit nervous and might intervene verbally in the market,” he said. “But the ECB will not commit to a fixed level.”

To contact the reporters on this story: Alessandro Speciale in Frankfurt at aspeciale@bloomberg.net; Andre Tartar in London at atartar@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net; Joshua Robinson at jrobinson37@bloomberg.net Paul Gordon, Jana Randow

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