Central banks face accusations that they are running out of ammunition in the battle to boost global growth. Mario Draghi has done his best to prove the sceptics wrong, firing off not so much a bazooka as a barrage of new measures to support the eurozone economy and rescue it from deflation. There is no guarantee he will succeed but the president of the European Central Bank has shown that he is determined to fight against pessmism that has gripped markets this year.
The ECB cut its benchmark interest rates to a new low, setting its refinancing rate at zero and moving its deposit rate further into negative territory. These rate cuts, however, were the that minimum investors had expected.
Mr Draghi strengthened his forward guidance, making it clear that interest rates would not rise for the foreseeable future. However, he said the ECB did not expect to cut interest rates again unless the economic outlook worsened. It opted against a tiered rate system - of the kind Japan has adopted to shield banks from the effects of negative rates - partly due to its complexity but also in order to make it clear that interest rates could not go down indefinitely.
This statement sends two important signals. First, that Mr Draghi shares some of the concerns about the effects of negative interest rates on the eurozone’s already-fragile banking sector. Second, that he does not want to implement negative rates in a way that would blunt their transmission to the real economy and lay the ECB open to accusations of engaging in currency wars.
Instead, the emphasis of the central bank’s package was on an aggressive expansion of quantitative easing. It will step up asset purchases from the current level of €60bn to a monthly €80bn, a bigger increase than expected. Crucially, it will now include corporate bonds in these purchases.
Finally, the ECB will alleviate the pain of negative rates for banks by a new offer of cheap loans. A series of targeted longer-term refinancing operations will offer more generous terms than previous TLTROs, and will include incentives for banks that step up their lending to the real economy. These could, in effect, be paid to borrow money. Overall, the measures are designed to be complementary.
Markets were not entirely convinced. The euro fell but bounced as Mr Draghi appeared to set a floor on interest rates. However, he has clearly chosen to avoid any suggestion of engaging in a race to the bottom in currency depreciation. Given the vagaries of foreign exchange markets, any such strategy would be unreliable. The ECB is right to recognise the need for stimulus and the weakness of the banking sector and to focus firepower on supporting lending and investment in the real economy.
None of this ensures that the latest stimulus package will work. The central bank’s updated forecasts make grim reading. Inflation is set to remain close to zero for the rest of the year, reflecting the fall in oil prices.
The eurozone recovery is likely to remain subdued, given the doubtful outlook for global growth. Regrettably, the ECB cannot count on any great contribution from fiscal policy or structural reform by eurozone governments. Some face political stasis; others are distracted by the migration crisis.
Not for the first time under Mr Draghi’s leadership, the ECB has broken new ground in unconventional monetary policy to tackle the eurozone’s endemically low inflation and sluggish growth. Once again, he has prevailed in the face of internal resistance led by Germany. Now it is time to allow his bold approach to work.
