Thursday, August 2, 2012

Eurozone - Draghi misses out on Olympic medal

In a way, today’s ECB meeting had a lot in common with the last EU summit in June. The ECB did not deliver the big bazooka some market participants had hoped for. It only gave some hints at intentions and possible plans for the future. Much ado about nothing?

Of course, the macro-economic assessment was of lesser importance today. Obviously, the ECB has become somewhat more pessimistic about the economic outlook. While the ECB still expects a recovery of the economy; this recovery has now been labelled as “only very” gradual. Risks to the economic outlook remain to the downside. As regards inflation, they put somewhat more emphasis on the fact that inflation would continue to slow down in the coming month, dropping below 2% in 2013. Risks to the outlook for price developments remain, according to the ECB, broadly balanced. This latest slight downward revision of the ECB’s macro assessment and the fact that a rate cut was already discussed today, in our view, has opened the door further for another rate cut. It could already happen at the next meeting in September when the ECB staff will present its latest economic forecasts.

Expectations about big things to happen were high. Last week, ECB president Draghi had pushed himself into a very uncomfortable corner. The words that the ECB would “within our mandate the ECB is ready to do whatever it takes to preserve the euro and believe me: it will be enough” had given rise to speculation about imminent ECB action. Clearly, today’s press conference was a cold shower for these expectations. The ECB did not present any new measures. In fact, ECB president Draghi stressed the well-known ECB stance that monetary policy could not solve the Eurozone debt crisis. Draghi actually repeated the old mantra that Eurozone policymakers needed “to push ahead with fiscal consolidation, structural reform and European institution-building with great determination.” However, Draghi’s comments also made clear that the ECB will not leave Eurozone governments standing alone in the rain.

How? The ECB implicitly announced an SMP 2.0. Draghi said that “the Governing Council…may undertake outright market operations of a size adequate to reach its objective” [of maintaining price stability]. Nothing has been decided, yet, and the emphasis is on the word “may”. According to Draghi, the ECB will now investigate options and details of such an SMP 2.0 programme. One element of the investigations will be the issue of seniority. Moreover, according to the ECB, “adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions.” It is obvious that the ECB will stick to a principle of strict conditionality. Unlimited bond purchases, therefore, look highly unlikely. However, combining conditionality to a measure which is officially meant to tackle problems with monetary policy transmission sounds somewhat contradictory.

What do we make of all of this? One, a rate cut at the September meeting looks highly possible. Two, the ECB will not engage in any ground-breaking measures like unlimited bond purchases. Three, ECB liquidity access for the ESM is out of the question right now but has not entirely been ruled out if the structure and tasks of the ESM have changed. Four, the ECB will stick to a principle of conditionality. For governments this means that they can only expect some ECB support if they send an official request to the EFSF/ESM.

All in all, the outcome of today’s ECB meeting had been less surprising or disillusioning without Draghi’s strong words last week. The ECB simply sticks to its well-known strategy. For Draghi, it was very hard to elegantly get out of such a self-inflicted dilemma. The ECB has to master a balancing act between keeping maximum pressure on Eurozone governments, while at the same time not disappointing markets. Draghi managed this split in only a very rough-and-ready manner. It will definitely not earn him an Olympic medal in gymnastics.

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