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Christine Lagarde and the case for more QE
MARIO DRAGHI is on his final stretch, and it's not an easy road to travel.
The European Central Bank president will chair a decisive governing council meeting next week, barely a month and a half before he hands over the reins to Christine Lagarde, the current chief of the International Monetary Fund. The ECB will almost certainly announce a hefty stimulus package on Thursday, including rate cuts, to try to lift dwindling inflation back towards the central bank's target of just below 2 per cent.
There's also a strong case for the ECB to restart quantitative easing, which ended last December - indeed, many economists expect Mr Draghi to announce a new round of bond purchases next week. But given the political delicacy around the return of QE, with the French, German and Dutch central bank governors all voicing scepticism, would it not be better to wait for Ms Lagarde to implement the change after she takes charge in November?
At a hearing in the European Parliament this week, Ms Lagarde promised to act with "agility" to combat dwindling inflation and said a "highly accommodative policy is warranted for a prolonged period". As such, the financial markets have a good indication that she'll follow Mr Draghi's lead in keeping things very loose. So perhaps it would be wiser to wait for her to thrash out the details of any controversial new asset purchase programme with the ECB's governing council (which includes all of the eurozone's central bankers).
The case for a new round of stimulus is certainly powerful. Inflation stood at 1 per cent in August, well below the central bank's target. Core inflation, excluding volatile items such as energy, tobacco and food, was even lower at 0.9 per cent. The eurozone - with Germany foremost - is grappling with a major external shock due to trade conflict between the US and China. The ECB is expected to revise its inflation and growth forecasts downward on Thursday.
The governing council needs to act forcefully to stop the deceleration of prices. A logical first step would be to cut the deposit rate further into negative territory from -0.4 per cent and to push out the date for when rates are expected to rise finally.
The council should examine whether there's a way to mitigate any damaging effects on the profitability of commercial banks from negative rates, but this ought not be a priority. A lower deposit rate should encourage lenders to do something more useful with their money than park it with the ECB.
The question of resuming net asset purchases is thornier. This idea is divisive for council members and would need technical adjustments to the previous QE scheme. For example, because of the ECB's already vast holdings of sovereign debt, it would have to raise the proportion of any nation's government bonds that it can own above the current 33 per cent cap. Germany has kept these limits.
Governments - Berlin in particular - should use extremely low interest rates to put together a coordinated fiscal stimulus and to re-balance economies towards domestic demand. The ECB must do its part too, of course, but it's Ms Lagarde who will have to own its policies for the next eight years. BLOOMBERG