Draghi’s parting shot leaves next ECB boss with existential dilemma

Christine Lagarde will face a momentous decision in her first year as European Central Bank President: give up on reviving inflation or give in to the temptation of bankrolling governments with neverending bond purchases.

The ECB pledged on Thursday to buy bonds “for as long as necessary” for inflation expectations in the euro zone to rise to its aim of just under 2 percent – a commitment that will haunt the central bank’s decision-makers long after current boss Mario Draghi steps down on Oct. 31.

With the bloc’s economy reeling from a global slowdown and incapable of generating enough growth domestically, the ECB could be in the market for years to come, gobbling up significant swathes of the bonds issued by indebted governments.

Squaring Draghi’s pledge with rules that ban the central bank from financing countries’ deficits, and increasingly vocal discontent from some unhappy ECB policymakers, will be Lagarde’s first challenge when she takes office on Nov. 1, the very day the bond-buying gets underway.

“A purchase program forever means either the final breach of all European Treaties and the beginning of full state financing… (unless) Draghi and his successor get what they want: an inflation rate of 2 percent or more,” Sentix, a Frankfurt-based research firm, wrote in a note.

Odds on the latter happening any time soon were long, with the ECB itself expecting inflation of just 1.3%-1.6% between this year and 2021 and market gauges of long-term price growth stuck even lower.

But Lagarde won’t have the luxury of waiting.

In roughly a year the ECB will have bought a third of Germany’s outstanding government debt, according to estimates by U.S. brokerage Jefferies, coming up against a self-imposed limit.

Scrapping that cap – designed to prevent the ECB from becoming a blocking minority in any debt restructuring – or diverting purchases to other countries would likely invite fresh legal challenges and accusations Frankfurt is rewarding profligate governments.

But giving up on the ECB’s mission to bring inflation back to its target was not an option for an institution that has price stability as its sole aim.

Lifting of the share of a country’s debt that the ECB could own – likely to 50%, which would still prevent it from becoming the majority owner – was seen by analysts as a possible solution.

This would see Frankfurt go down the route of the Bank of Japan (BoJ), which has hovered up 45% of its government’s debt as part of an increasingly desperate effort to revive a stagnant economy via quantitative easing (QE) and fiscal largesse.

“This is QE forever and a next step in the euro zone’s Japanification,” Carsten Brzeski, an economist at Dutch bank ING said. “The conclusion that only fiscal policy can still make a difference also echoes Japanese experiences.”

But new ECB President Lagarde would be likely to face pushback on such a move from a sizeable section of the Governing Council, more than a third of which opposed new bond purchases on Thursday, including the central bank governors of France and Germany.

“The very fact there are so many members opposing this could act as an anchor preventing the ECB from following the BoJ,” Angel Talavera, an economist at research group Oxford Economics, said.

POLICY REVIEW
Lagarde has a wild card, however. She has hinted at launching a review of the ECB’s tools and policy framework to weigh up their costs and benefits.

Economists said this could be used to bolster the case for even more stimulus or, on the contrary, acknowledge that the current inflation target is too ambitious and money taps must be finally closed.

When the ECB was founded in 1998, its main preoccupation was to stop prices from rising too fast.

It set its central goal as an inflation rate of “below 2 percent”, tweaked to “below, but close to, 2% over the medium term” in 2003 to clarify that deflation – or falling prices – would not be tolerated.

But that level of price growth has proven elusive since the euro zone debt crisis of 2010-12 due to a combination of sluggish lending, weak domestic demand in peripheral countries and excess savings in Germany.

While nothing is known yet about the spirit of Lagarde’s review, Dirk Schumacher, an economist at French bank Natixis, said he saw it as increasingly difficult for QE supporters to justify more largesse.

“The burden of proof is shifting and if inflation has gone nowhere a year from now it will be hard for the doves to say we need more of the same,” Schumacher said.

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86 Thoughts to “Draghi’s parting shot leaves next ECB boss with existential dilemma”

      1. Reginald Elejere

        Yes that is a nice work. Looks so beautiful

    1. Olalekan Ekiyoyo Afolabi

      This could be used to bolster the case for even more stimulus

    1. abiodun akindele Daniel

      Thanks for the information anyway

  1. Kelvin Narh

    the next EC boss has to strategize plans to overcome the dilemma

  2. Oyeyemi Tunde

    incapable to grow inflation

  3. Nurudeen Afeez

    Incompetent for growing inflation

  4. Ifeayi Emmanuel

    That is why she is a leader is to face challenge

  5. Ibrahim Seagren Ismail

    It won’t be easy for her

  6. Muhammed Kasim Baba

    old nice woman

  7. John mfreke Abasi

    Thanks for this information
    I really appreciate your work sir
    Long live Giftalworld

  8. Nwachukwu Claris urenna

    you just have to take it easy… slow and steady

  9. Toscobaby2000 Oluwafemi

    Nice one

  10. Toscobaby2000 Oluwafemi

    Better still all this is gr8

  11. okiemute emmanuel

    Interesting

  12. Olugbenga Oluwafunmilola Dorcas

    The ball is in her court

  13. Christopher Ehimwenma

    That’s really nice

  14. Iyanuoluwa Eniola

    Draghi and his successor get what they want: an inflation rate of 2 percent or more

  15. Olanrewaju Oluyemi

    lagarde is cool

  16. Olanrewaju olamilekan

    Oh so sad for her

  17. Nkiruka Umetali

    she should think well

  18. Akuruka Sunday

    Wow..make a good decisions oo

  19. Onyekachi Peter

    Wow that’s good

  20. Usiakpor Happiness

    just be strong

  21. Adedeji Peace

    Strategies are needed to overcome the dilema

  22. ORAZULUME CHINEMEREM

    Good to know

  23. Nancy Christopher

    it’s not an easy task but she need to be optimistic about her new appointment

  24. Micheal Joseph Ugande

    Alll this can be done if only there’s a compromise

  25. Onawola Adeyinka Stephen

    That s right

  26. Chidera Obulu

    Well let them carry on

  27. Izukanne Chinazo

    So sad for that

  28. Joesmart Chukwu

    Wish them well

  29. Priscilla Olorunfemi

    Thanks for the news

  30. Adelanwa adebiyi

    Wish them well

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