Mario Draghi just got evidence that his call for “prudence” in withdrawing European Central Bank stimulus applies to his words too.
The euro and bond yields surged on Tuesday after the ECB president said the reflation of the euro-area economy creates room to pull back unconventional measures without tightening the stance. Policy makers noted the jolt that showed how hypersensitive investors are to statements that can be read as even mildly hawkish, according to three Eurosystem officials familiar with their thinking.
Draghi’s speech at the ECB Forum in Sintra, Portugal, was intended to strike a balance between recognizing the currency bloc’s economic strength and warning that monetary support is still needed, said the officials, who spoke separately and who asked not to be named as internal discussions are confidential. Vice President Vitor Constancio scrambled to set the record straight, saying the remarks were “totally” in line with existing policy and the response by investors was hard to understand.
An ECB spokesman declined to comment.
The euro fell almost a cent after the report and traded at $1.1336 at 3:05 p.m. Frankfurt time. European stocks rose and the yield on German 10-year bonds slipped. The single currency jumped 1.4 percent on Tuesday and extended its gain to the highest level in a year earlier on Wednesday.
“I don’t think his speech was a big surprise, but you saw the market reaction,” said Joachim Fels, global economic adviser at Pacific Investment Management Co., who attended the forum. “It’s a warning sign that there are some unintended consequences as central banks head toward the exit.”
The ECB is entering a delicate period with its 2.3 trillion-euro ($2.6 trillion) bond-buying program currently scheduled to end in December. With inflation still short of its goal of just under 2 percent, the Governing Council didn’t discuss at its June 8 meeting how and when it might wind down purchases, and doesn’t see a need to take a decision until at least September.
A key concern for the central bank is that too-hasty communication that stimulus is on the way out may have an outsized impact on bond yields and bring about an “unwarranted tightening of financial conditions” that would jeopardize the economy’s progress so far. Draghi stressed exactly this point in his Tuesday speech.
“We need prudence. As the economy picks up we will need to be gradual when adjusting our policy parameters, so as to ensure that our stimulus accompanies the recovery amid the lingering uncertainties.”
Yet by avoiding formal discussion of any tapering of quantitative easing until late in the year, the ECB raises the risk of more market volatility when speeches such as Draghi’s hit, especially over the summer months when liquidity is typically thinner. The ECB chief also stressed the need for persistence in maintaining monetary accommodation, but investors focused on his line about the scope for policy tweaks.
“As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged.”
Constancio’s response in a CNBC interview broadcast the next day was to stress the need that inflationary pressures remain subdued even amid an economic upswing that should already be pushing up prices and wages.
“If we want to bring inflation to our target of below but close to 2 percent then we have to persist in the type of monetary policy that we been adopting.”
The concern for Constancio and other policy makers is that there may be more slack in the euro-area economy than previously thought. He cited ECB research showing a broader measure of joblessness, including those who want to work more hours but can’t, could be as high as 18 percent, almost twice as high as the official rate.
The Governing Council next meets to set policy on July 20, though most economists see little chance of a substantial change in the policy stance until the following meeting on Sept. 7.
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