Mario Draghi, the president of the European Central Bank, has stunned markets by signalling that he is prepared to cut interest rates and step up quantitative easing to stave off the risk of a renewed economic slump in the eurozone.
The value of the single currency dropped sharply on foreign exchanges on Thursday as Draghi announced that the ECB’s governing council had discussed expanding its €1.1tn (£795bn) bond-buying programme and cutting the rate on reserves held at the central bank.
This “discount rate” is already negative, at -0.2%, meaning banks effectively have to pay the ECB for holding their reserves – a measure aimed at keeping money flowing around the economy.
Speaking after the ECB’s latest policy meeting in Malta, Draghi revealed that some members of the governing council had favoured taking more action to stimulate the economy immediately. He blamed the slowdown in emerging markets, including China, for renewed weakness in the eurozone.
“While euro area domestic demand remains resilient, concerns over growth prospects in emerging markets and possible repercussions for the economy from developments in financial and commodity markets continue to signal downside risks to the outlook for growth and inflation,” he said in his opening statement.
Draghi said the ECB could also step up the scale of QE. A decision is likely to be made at the December meeting of its governing council, when its latest economic forecasts will be available. As Draghi spoke, the euro dropped by 1.5 cents against the dollar, to $1.117.
“The governing council is willing and able to act by using all the instruments available within its mandate, if warranted, in order to maintain an appropriate degree of monetary accommodation,” Draghi said.
He added that he and his ECB colleagues would not be in “wait and see” mode, but rather “wait and assess” mode, between now and their policy meeting on 3 December.
“The ECB will almost certainly be delivering an early Christmas present this year,” said Nick Kounis, the head of markets and macro research at investment bank ABN Amro.
Draghi is an enthusiastic proponent of “forward guidance”, the strategy of sending strong verbal policy signals in order to shift financial markets – in this case, driving down the euro.
His dramatic pledge in the summer of 2012 – in the middle of the Greek debt crisis – that the ECB would do “whatever it takes” to save the single currency helped to reassure panic-stricken investors.
Jeremy Cook, the chief economist of international payments company World First, said ECB policymakers were likely to have become increasingly concerned in recent weeks about the strengthening of the currency, which makes eurozone goods less competitive on international markets.
“Draghi and the executive council couldn’t have been clearer that additional policy easing was coming if they’d had the words ‘sell the euro’ tattooed on their faces,” he said.
Euro area GDP rose 0.4% in the second quarter of 2015, a slight slowdown from 0.5% growth in the previous quarter.
However, a stream of downbeat data from Germany, the eurozone’s largest economy, including the sharpest decline in exports in six years, has stoked fears about a downturn.
There are also concerns that the repercussions of the emissions-fixing scandal at German carmaker Volkswagen, one of the pillars of its industrial sector, could undermine the strength of the economy. Asked about the potential impact of events at VW, Draghi said: “It’s very, very early to say.”
Draghi’s comments about the possibility of reducing the discount rate further below zero will also rekindle debate about whether borrowing costs could eventually be pushed lower in the UK, where the base rate has been at 0.5% since March 2009.
Andy Haldane, the Bank of England’s chief economist, has argued that a rate cut might eventually be necessary, but other Bank insiders believe there is little to be gained when rates are already so close to zero.
Jennifer McKeown of consultancy Capital Economics predicted that the ECB would step up the pace of bond purchases in December, perhaps to €80bn a month from €60bn currently, and could also extend the QE programme beyond its planned end date of September 2016.
She argued that this could significantly weaken the value of the euro as the US Federal Reserve prepares to tighten monetary policy.
“With US interest rates still set to increase next year, the prospect of a substantial divergence of monetary policy between the eurozone and the US implies downside risks for the euro versus the US dollar.”
