Draghi: My endless dove

Elliot Clarke at Westpac:

In July, President Draghi held closely to the tone and narrative conveyed at the June meeting. Of note in the press conference were a number of key points on: the path for policy; the consequence for the Euro; and the need for fiscal authorities to aid the economy, the latter representing the key risk to Europe.

Beginning with the path for policy, there was no change in the language used to describe the asset purchase program. This was also true of the forward guidance on interest rates which are set “to remain at their present levels at least through the summer of 2019 and, in any case, for as long as necessary”.

Asked in the Q&A to clarify whether “through the summer” meant a first hike would come during or after summer 2019, President Draghi pointed to “expectations of the future path of the policy rates”. Specifically he highlighted that market pricing for the deposit rate (which sees a first hike in October 2019) was “very well aligned with the anticipation of the Governing Council”. Ergo, September or October 2019 would be the first meetings where a deposit rate hike would be considered.

Underlying this view is a belief that, while growth has slowed, it will maintain a robust pace hence, well ahead of potential growth. As a consequence, the Euro Area labour market will continue to improve, aiding income and confidence. Supporting this expectation, it was noted that wage gains have outperformed in 2018, with negotiations between employees and employers becoming more constructive. While this has given the Council greater confidence in the outlook for inflation, the reality is that core inflation remains stuck around 1.0%yr. Hence “prudence, patience and persistence” are still seen as the keywords to “inform” and “inspire” monetary policy.

Regarding the Euro’s depreciation against the US dollar and remarks by President Trump on active devaluation, President Draghi highlighted during the Q&A that “different monetary policies do reflect the response of monetary authorities to different positions in the business cycle” and that “We [have] said several times that the exchange rate is not a policy target”.

Backing the ECB’s view, “if one looks at the nominal effective exchange rate of the euro vis-à-vis all the [trading] partners… the euro has appreciated considerably over the last year“. The conclusion to draw here is that US dollar strength is simply a consequence of the US’ economic and policy outperformance, not the ECB’s doing.

Turning then to fiscal policy, there were two points of note. The first was another call to make the composition of public finances “more growth friendly” while also rebuilding fiscal buffers.

This has been a near constant refrain from President Draghi in recent years, one that gains more and more significance each quarter. The reason this is the case is that the longer the growth cycle runs, the less momentum depends on the release of pent-up demand and is instead driven by productivity and opportunity for profit. If productivity is not fostered and debt kept in check, an outcome that seems unlikely given political malaise, then abovepotential growth will be much harder to sustain. That then leads to the second fiscal issue: bilateral and multilateral trade relations.

The agreement made between EU Commission President Juncker and US President Trump this week to enter negotiations on trade was viewed favourably by the ECB. However, because detail is absent, it is too early to assess potential economic benefit. The agreement will diffuse market tension for now, providing hope that global trade negotiation will not disintegrate into tit-fortat tariff dramas or an outright trade war, but only time will tell if this truce is temporary or lasting.

Honestly, given the precariousness of the European periphery, I don’t know why anyone expects the ECB to ever exit anything.

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