mobanmarketBrexit has provided Mario Draghi with an unsolicited assist.
Britain’s surprise decision to leave the EU could help the soccer-loving European Central Bank chief to do even more of “whatever it takes” for the eurozone. The likely economic shock about to hit the Continent should strengthen Draghi’s hand against German-led opposition to more monetary stimulus, both within the ECB and in the political arena.
For the time being, though, no one is taking victory laps around the ECB’s austere tower in Frankfurt.
In fact, Draghi went out of his way on Thursday to star in an uneventful press conference following an uneventful meeting of the central bank’s governing council that left both rates and stimulus measures unchanged.
He only mentioned the U.K. vote six minutes into his opening statement and even then, only in passing in the middle of a long list of potential risks to financial and economic stability. When reporters raised more questions, he said little other than the obvious: that markets have been resilient in the face of the shock of the Leave victory in the June 23 referendum.
He did make news, but on a different subject. Draghi sent European bank shares soaring with his backing of a “public backstop” to solve the chronic issue of bad loans saddling many eurozone lenders — a seeming nod of approval to the Italian government’s efforts to rescue its troubled banking system.
Draghi’s reluctance to take on Brexit is no surprise. In the short term, economic turbulence, nervous investors, and the cloud of political uncertainty from Britain’s semi-detached status within Europe will make the ECB’s job harder, not easier.
Slower growth
But as summer turns to fall, and the outline of the U.K. vote’s economic fallout becomes clearer, Draghi might call upon the “Brexit effect” in his battle with the hawks in the ECB’s midst. The key date, in this respect, is September 8, the first ECB meeting after the summer.
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Investors are already expecting some radical action, especially if the ECB’s own forecasts show that economic growth is too slow to achieve the elusive goal of “price stability,” or an annual inflation rate of around 2 percent.
The market consensus for the September meeting is for a cut in eurozone interest rates further into negative territory, an extension of “quantitative easing” measures beyond their March 2017 expiration and possibly, a change in their structure to make it easier for the authorities to buy increasingly scarce bonds.
“In September the ECB will release a new batch of forecasts” wrote Gilles Moec, a Europe economist at Bank of America Merrill Lynch, in a note to clients ahead of Thursday’s meeting. “We believe it will continue to be inconsistent with achieving price stability within any reasonable policy relevant horizon. Not acting then would in our view dent the ECB’s credibility.”
But action is not a certainty for an institution that, like all EU bodies, has to balance the conflicting interests of its many members.
Draghi knows the challenge first hand, having been lambasted by German politicians in recent months for hurting savers, insurance companies, and banks with a negative interest rate. (He responded by blaming Germans for saving too much.) Given Draghi’s consummate skills as a political operator, signs of an economic downturn following the British vote may make those debates inside and outside the ECB that much easier.
The Bank of England could also help. Unlike their European counterparts, hard-working British central bankers don’t take the whole of August off. In fact, they are widely expected to cut rates and expand their own QE package at their August 4 meeting.
In the short term, that could complicate the ECB’s job, since the U.K.’s monetary easing could weaken the pound and strengthen the euro, undoing some of the work done by the Frankfurt authorities. But overall, having a barrage of BoE stimulus alongside the ECB’s heavy artillery could help to both bolster economic growth and convince the skeptics that more is needed.
‘Large uncertainties’
Much will depend on how bad the Brexit effect is.
The ECB’s first assessment was relatively benign, with a forecast of a hit to eurozone GDP of up to 0.5 percentage points over the next three years. That’s not chump change given that before the referendum, the ECB had estimated the eurozone economy would grow by 1.6 percent in 2016 and 1.7 percent in 2017.
But it’s less than what some private-sector economists expect. Merrill Lynch’s Moec, for example, has already reduced his growth estimates by 0.5 percentage points for 2017 alone, from 1.6 percent to 1.1 percent.
On Thursday, Draghi seemed keen to bridge that gap, stressing that the ECB’s estimates had to be taken “with a grain of caution” due to the “large uncertainties that prevail.”
Such central bank-speak for “we don’t know, but it could get worse” echoed similar caution from the European Commission this week. In releasing a forecast that was similar to the ECB’s in terms of Brexit’s impact on eurozone growth, the Commission pointed to the potential for further economic harm.
“The referendum has created an extraordinarily uncertain situation,” the report said. “Due to the lack of information about the new equilibrium after the U.K.’s exit, many elements have not yet entered the assessment but nevertheless constitute substantial risks to the outlook.”
Brexit’s economic and policy ramifications for the ECB won’t be known for some time. But as an Italian soccer fan, Draghi knows that the final result is all that counts, even more than how it is achieved.
Put differently: Whatever it takes.