European Central Bank President Mario Draghi’s remarks Thursday were a reminder that he faces two increasingly tricky challenges: balancing stronger-than-expected economic expansion against continued monetary stimulus; and overcoming “lowflation” in the context of a further appreciation of the euro currency.
Reflecting the view of the ECB’s Governing Council, Draghi welcomed the region’s “increasingly solid and broad-based expansion,” noting that both internal and external drivers were working together. At a news conference in Frankfurt, he acknowledged what has been reflected in markets for a while -- that the “continuous strengthening of the economy" has been "to some extent more than expected.”
This economic reality has to be balanced against the ECB’s desire to maintain “an ample degree of monetary accommodation” to avert a premature tightening of policy that could derail a relatively fragile recovery. To this end, Draghi reminded markets there is no change in the expected sequencing of monetary policy changes, with no interest rate increase before the end of the securities purchase program known as quantitative easing. He cited the statement by a member of the Governing Council who said the sequencing is “written in stone” and that the timing of a rate rise would be “well past” the end of QE. As a result, he observed, there were “very few chances" that interest rates would be raised in 2018.
This does not mean there is no monetary policy debate within the ECB.
Draghi reminded markets that, while the monthly purchase program of 30 billion euros ($37.5 billion) would continue until September as previously stated, the Governing Council will debate its evolution thereafter -- specifically, “a sudden stop versus a gradual tightening.”
The second delicate balancing task facing the ECB concerns inflation and the currency.
The central bank's goal of raising inflation toward the 2 percent target is complicated by the disinflationary effects of the recent appreciation of the currency (which Draghi diplomatically referred to as “exchange-rate volatility” that, together with geopolitics, are “sources of uncertainty”). And while some see U.S. Treasury Secretary Steven Mnuchin’s comments in Davos on Wednesday as a catalyst, the weakening of the dollar this year is reinforcing a tendency that started a full year ago -- and this is occurring in the context of what Draghi characterized as “muted” price pressures in the euro zone that have yet to show "convincing signs of a sustained upward trend."
Fortunately for Draghi and his colleagues on the ECB Governing Council, three well-identified and feasible measures would help balance these competing claims on policies and the economy. Two were explicitly mentioned at Thursday's news conference, and one almost was.
As to the former, progress by member countries in implementing pro-growth structural reforms and in completing the region's economic/financial architecture would help deepen and broaden the regional expansion, allow for an orderly and timely normalization of monetary policies, and turn the “bad” inflationary consequences of currency moves into better ones.
The conduct of fiscal policies also is important. Draghi focused on the importance of using this window of growth to solidify fiscal consolidation where needed. He could have also added the scope for looser fiscal policies in the few countries that already have solid economic and financial fundamentals. Indeed, a gradual and cautious tilt in the fiscal-monetary balance in these specific cases, that is more fiscal and less monetary stimulus, could contribute over time to overall economic welfare and financial stability.