03 March 2017

Financial Times: Draghi should resist calls to prepare exit from QE

The euro area economy grew by 1.7 per cent in 2016. Surveys suggest activity is at its strongest since 2011, with the fastest rate of job creation in almost a decade. Corporate profits are growing faster than in the US. And inflation is back too, climbing to an annual rate of 2 per cent in February. The ECB’s mandate is to keep it just below that level.

Mario Draghi therefore faces calls from longstanding critics of the ECB’s stance to signal that the central bank is no longer considering any additional stimulus and may instead be preparing to scale back its emergency measures. The ECB president should continue to resist this pressure when he presents new forecasts for the eurozone economy next week.

There may be a case for the ECB to temper its gloomy outlook. But this should in no way be taken to mean that it is heading for the exit. Despite stronger global growth and the prospect of rising US interest rates, even the most hawkish on the central bank’s governing council agree that the ECB’s sub-zero interest rates and extensive bond-buying programme are still necessary, given the modest pace and uneven nature of the recovery. Unemployment close to 10 per cent remains higher than before the 2008 crisis. Italy’s economy is growing at around half the speed of Germany’s.

Crucially, the rapid return of inflation is almost entirely due to the recovery in oil prices. Core inflation, which strips out changes in food and fuel prices, is a mere 0.9 per cent. So while the ECB may raise its forecast for 2017 inflation by as much as half a percentage point next week, there is likely to be little change in the outlook for 2018 or 2019. Stimulus is still needed if inflation is to return durably to target.

It is true, though, that the eurozone no longer seems likely to tip into outright deflation. It would be reasonable for the ECB to take a less gloomy view of the balance of risks. The trouble is that those who have always disliked its ultra loose policy will seize on any change in language as the first step towards tapering of quantitative easing. German politicians are already calling on Mr Draghi to “prepare the beginning of the end”. Starting down this path now would be premature.

The ECB has twice made the mistake of tightening policy too early — in 2008 and in 2011, when it amplified the eurozone debt crisis. Moreover, it has already announced — without clear justification — that it will scale back its monthly bond purchases from €80bn to €60bn from April.

Meanwhile market interest rates have risen, reflecting trends in global markets, so that financial conditions have arguably delivered the equivalent of monetary tightening. And while some risks have receded, there is still plenty to worry about on the political front. German sensitivity is understandable in an election year. Inflation in Germany has already risen above 2 per cent, eroding the real return on savings and exacerbating the resentment many already felt at negative nominal rates. But Germany’s chronically deficient demand is a large part of the reason why monetary policy has had to be so aggressive. It would be better for this pressure to translate into calls for higher wage growth than for it to choke off recovery in the eurozone’s weakest economies. For the first time in years, the eurozone economy is in a reasonable state of health. Let’s keep the convalescence going. 

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