Central banks have painted themselves into a corner with their own forward guidance. Even as the US Federal Reserve wrestles with its commitment to increase rates as the US economy stumbles, the European Central Bank, in its press conference last Thursday, felt obliged to stick to its pledge to end its asset purchases even though European growth is slowing.
“The latest data and survey results have been weaker than expected,” ECB President Mario Draghi said at the news conference following last week's governing council meeting. “This may suggest some slower growth momentum ahead.”
But the central bank nonetheless said it will end asset purchases, currently running at 15 billion euro a month, with this month’s investment. However, the ECB will continue to reinvest maturing principal and maintain its bond holdings at €2.6 trillion for the foreseeable future. Draghi’s concession to slower growth was that this reinvestment can continue even after the ECB starts raising interest rates, which won’t happen before the end of next summer.
The purchases will continue “as long as necessary to maintain favorable liquidity conditions and an ample degree of monetary accommodation.” Draghi wants “as long as necessary” to have the same effect as “whatever it takes” to reassure markets.
Even as central banks defend their need for independence in conducting monetary policy, however, it is clear they are playing politics. Draghi needed to make the commitment to end the quantitative easing program and keep to it because of German pressure to do so. On the face of it, the European economy needs the stimulus just as much next month as it does this month so the decision to stop is looking arbitrary – or politically motivated.
The same is true in the US, where the situation is exacerbated by President Donald Trump’s overt attacks on Fed policy. The Fed is setting the stage for slowing its interest-rate increases next year, but can hardly abandon the planned rate hike next week without seeming to bow to the president’s wishes. Nonetheless, there is virtually no inflationary pressure, expectations on the price front remain well-anchored, and the economy is weakening.
In Europe, Germany actually registered negative growth in the third quarter. Even though economists attribute the downturn to the failure of carmakers to certify new models under tougher emissions standards, forcing them to cut back production and sales, economists have trimmed growth forecasts in Europe’s largest economy to 1.5 percent from 1.8 to 1.9 percent both for this year and next year.
The ECB lowered its forecast for growth in the EU as a whole to 1.9 percent this year, off 0.1 points from previously and to 1.7 percent next year, down a similar amount.
Many analysts feel the ECB missed its chance to stop the asset purchases some months ago, when forecasts were more optimistic. They fear that circumstances will be equally unfavorable for raising rates next fall. And yet, during his press conference Draghi seemed satisfied that investors understood the ECB’s desire to wait rather than start raising rates too soon, then having to backpedal.
The quandary is that low rates invite more debt. As such, the longer the ECB waits, the more of a debt load countries will take on. Italy is resisting limiting its deficit in order to slow its indebtedness and its contretemps with Brussels is creating tension throughout the bloc.
Draghi managed to levitate through all this, maintaining an attitude of confidence and ending QE as promised, even as forecasts for growth and inflation were cut. Much of his success rests on his personal credibility.
The effect will fade as he moves into real lame-duck status next year. With the parameters now basically set for his remaining time in office, the focus will shift to who will replace him and how that will change policy.