Thursday, May 3, 2012

Draghi's inconvenient truth

At today’s meeting in Barcelona, the ECB left interest rates unchanged. The ECB looks set to keep rates unchanged for a long while. ECB president Draghi’s main message at the press conference could be an inconvenient truth for those hoping for a quick fix of the euro crisis.

The ECB’s macro-economic assessment was almost a verbatim copy of the April meeting. According to the ECB, the economy stabilised in the fourth quarter, albeit at a low level, and economic activity is expected to recovery gradually over the course of the year. Risks to the economic outlook remain to the downside. As regards inflation, the ECB expects headline inflation to stay above 2% in 2012. Probably with German wage negotiations in mind, the ECB still mentions possible signs of second-round effects from higher energy prices. However, in the ECB’s view, risks to the inflation outlook remain broadly balanced.

With a virtually unchanged macro-economic assessment, it did not come as a surprise that according to Draghi the ECB did not discuss rate changes at today’s meeting. As regards the future path of monetary policy, Draghi kept a low profile. In his view, the monetary policy stance was still accommodative. At best, the only two policy-relevant comments were that an exit discussion was premature and that the ECB would decide on the full allotment in its liquidity operations at the June meeting. In our view, clear signals that rates will remain on hold and that ample liquidity operations will remain the ECB’s main policy instrument.

In the absence of essential news on monetary policy, the discussion at today’s press conference was mainly focussed on growth, or better the lack of growth in the Eurozone. Against the background of a further weakening of the Eurozone economy and record high unemployment in many Eurozone countries, the policy and political debate is more and more shifting towards growth. A growth compact has been the new Eurozone buzz word. At today’s press conference, Mario Draghi stressed that a growth compact was not a substitute for fiscal consolidation but rather an addition to austerity measures and structural reforms. In more detail, Draghi’s growth compact should comprise three elements: i) structural reforms in labour and product markets; ii) a revamping of European investment programmes through the EIB or EU funds; and iii) a clear vision for the future of the euro. With a clear call on politicians for a long-term view on the future of the monetary union, Draghi is finally filling the shoes of his predecessor Trichet as the real Mr. Euro.

In our view, Draghi’s call for a growth compact is a plea to politicians, not a hint to further rate cuts. To the contrary, the history of the ECB has shown public pressure on the ECB can be very counterproductive. Remember former ECB president Duisenberg’s saying that central bankers are like cream – the more you whip them, the stiffer they get.

With today’s press conference, Draghi has sent a painful reminder that the ECB cannot solve the current crisis. The ECB will not hesitate to accompany and smoothen this adjustment process but national governments have to be in the lead to do the dirty work. As a result, there does not seem to be any quick fix or alleviation for the economy in the offing. An inconvenient truth.

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