17 April 2014

Reuters: ECB hardliner Weidmann comes in from the cold as deflation threatens

As recently as last November, Jens Weidmann steadfastly opposed any move by the European Central Bank to print money to buy assets and buoy the eurozone economy. This is no longer the case.

The Bundesbank chief, known for his hardline stances at the ECB and as head of the German central bank, is now ready to support such quantitative easing (QE) if he and his ECB colleagues deem it necessary. What has changed is that "the situation has changed", according to one person familiar with the German's thinking, speaking on condition of anonymity.

Eurozone inflation has slowed to 0.5 per cent from 0.9 per cent in November, falling far below the ECB's target of just under 2 per cent and stoking fears the bloc could become stuck in a prolonged period of so-called "low-flation", or even sink into outright deflation. 

Such a scenario risks undermining the efforts of crisis-hit countries on the eurozone periphery to shape up their economies, and could ultimately hit growth across the board if households defer purchases in anticipation of lower prices in the future. Seeking to head off such a drop in inflation expectations, the ECB's governing council said earlier this month it was unanimous in its commitment to use unconventional tools - central bank-speak for things like QE - to counter a protracted period of low inflation.

The unanimity meant Weidmann was on board. This matters because as leader of the hawkish faction on the 24-member council, he can shape debates and restrict policy moves. Last May, for example, he prevailed in limiting the size of an interest rate cut.

"I actually think Weidmann is quite pragmatic, as long as he is convinced the bank is absolutely focusing on monetary policy and not pursuing objectives of government financing," said Clemens Fuest, head of Germany's ZEW economic institute. "That was his concern with the OMT programme. But I think QE is another story," added Fuest, who also advises the government in Berlin. "Of course, drawing the line is not easy. But with quantitative easing, drawing the line is not impossible either.

By acting pre-emptively, even just by talking about QE at this stage, "the action itself doesn't need to be as large", said Berenberg bank's Christian Schulz, a former ECB economist.

With Berlin having pledged billions of euros in taxpayers' money to bail out debt-ridden euro zone countries, German voters expect the Bundesbank to act as their economic rock. By remaining "in the room", Weidmann can try to influence the details of an asset-purchase plan should the ECB prepare to launch one.

As well as potentially posing a risk to economic growth, very low inflation or even deflation aggravates the adjustment process of debt-saddled countries on the euro zone periphery, which the Bundesbank has been pressing to shape up. Low inflation across the euro zone gives the countries on the periphery less scope for relative price adjustment against more competitive economies like Germany, and also makes it harder for them to reduce their debt piles.

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© Reuters