With Draghi completing his term, the ECB looks increasingly powerless

Ferdinando Giugliano Mario Draghi has had quite a few difficult days at work since he became president of the European Central Bank. From the risk of a euro collapse to the threat of outright deflation, Draghi has seen off the sceptics and exceeded expectations about what the ECB can do.

And yet, when the bank’s governing council meets this week, its policy-makers will be grappling with a new challenge. The economic outlook — while troubling — is clearly more benign than during the height of the euro zone debt crisis. But with Draghi due to step down at the end of October, the ECB faces a credibility problem about whether his replacement will be up to the job.

In the meantime, it’s best that Draghi acts forcefully now on the economy rather than wait until the macro situation gets worse.

Inflation woes

The main concern is the outlook for inflation, which is well short of the central bank’s target of just below 2 per cent. On Tuesday, official statistics showed that the euro zone headline inflation rate stood at 1.2 per cent in the year to May, down from 1.7 per cent in April.

Core annual inflation, which strips out volatile items such as food and energy, was 0.8 per cent. This decline is due partly to calendar effects, so price pressure should increase mildly in June.

But inflation expectations are plummeting: Five-year forward five-year inflation swaps, a measure of the market’s future estimates, were down to 1.28 per cent on Tuesday, very close to an all-time low.

In fairness, the euro zone economy hasn’t had a bad start to the year.

Quarterly growth recovered to 0.4 per cent in the first three months, and unemployment keeps falling — down to 7.6 per cent in April, its lowest point since August 2008. The slide in the inflation swaps’ measure appears driven by changes in global risk premiums and only to a lesser extent by “actual” inflation expectations, according to the ECB and independent analysts. And, with the exception of Italy, bond yields in the euro zone’s weakest member states are under control (if anything, they’re too low).

These aren’t the kinds of scares that prompted Draghi to announce he would do “whatever it takes” to rescue the euro or launch quantitative easing to prevent the monetary union from turning into deflationary Japan.

The trouble is that the ECB is looking increasingly powerless. It has plenty of weapons to restart growth if the euro zone ends up on the brink of a new recession — for one, it could restart its net bond purchases. But the risks for the single currency come increasingly from outside the domain of monetary policy.

If US President Donald Trump wants a full-blown trade confrontation with China, there’s little Draghi or his successor can do.

Generous on loans

Most important, the ECB’s ability to counter any shock hinges on the men and women running it. Philip Lane, who’s just replaced Peter Praet as the bank’s chief economist, will add some much-needed intellectual flair and rigour to the executive board. But as long as questions remain over the next president, the ECB’s effectiveness will be muted.

For now, Draghi can show he still controls the message. The ECB is to offer a fresh round of ultra-cheap loans to banks so they can keep lending at favourable rates to families and businesses. It hasn’t yet announced the pricing of the loans, but it should be as generous as possible given the worsening global outlook.

There’s a case too for considering a new cut in its negative deposit rate, which banks pay for parking their money with the central bank. This will also help keep down the value of the euro, which has edged up since investors have started betting on a rate cut by the US Federal Reserve.

Draghi won’t want to tie the hands of his successor, but he must make sure the ECB stays as supportive as it can until he steps down. A last effort is needed from the man who saved the euro. Bloomberg

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