Draghi will not hesitate to zero ECB’s basic interest rate

European Parliament. Committee on Economic and Monetary Affairs (ECON) meeting. Hearing with Mario Draghi, ECB President but also as Chairman of the European Systemic Risk Board. (EP Audiovisual Services).

European Parliament. Committee on Economic and Monetary Affairs (ECON) meeting. Hearing with Mario Draghi, ECB President but also as Chairman of the European Systemic Risk Board. (EP Audiovisual Services).

Combining what Mario Draghi, the President of the European Central Bank, said yesterday about low inflation projections and the Governing Council’s forward guidance of the economy, the conclusion one can draw is that, the ECB’s basic interest rate will remain at its present (0.25%) or lower levels for the next two years, at least well into 2015. By the way, the Governing Council left this rate unchanged yesterday at the above level, which was set early in November, when it was reduced from its previous 0.5% setting.

Traditionally ECB’s Governing Council holds its monthly meeting the first Thursday of every month. Yesterday the council was also attended by the Commission Vice-President, Ollie Rehn, responsible for Economic and Monetary Affairs and the Euro.

The reduction of ECB’s basic interest rate from 0.5% to 0.25% last month attracted a tsunami of reactions from Germany, objecting to this small decrease of the cost of money, on the grounds that it reduces the incentive to save. However, a quarter of a percentage unit less interest cannot really affect savings. In any case Germany, with its austere economic ideology, doesn’t favour cheap money. On top of that this country is nowadays awash in cash.

Not any more Germany’s ECB

But it was not only that. Almost the entire financial sector of Germany then rose to its feet for one more reason. It was the first time that the ECB, under the strong leadership of Mario Draghi, took exactly the opposite decision, from what the two German members of its Governing Council had longed for. Jörg Asmussen and his compatriot Jens Weidmann President of Deutsche Bundesbank, both voted against the reduction of the interest rate. As it was left to be understood later on, the two considered this step as premature. For the first time however they couldn’t manage to secure enough votes to support their opinion.

This must have been the reason that Draghi, when answering the first question from journalists yesterday, commenced his response like that: “First of all, our decision to cut rates in November has proved to be fully justified. Our monetary policy stance will remain accommodative for as long as necessary, and will thereby continue to assist the gradual economic recovery in the euro area”. In this way he wanted to tell Asmussen and Weidmann two things. Firstly that the two Germans were wrong and they had better admit it. Secondly he clarified that the ECB wouldn’t any more follow the German Bundesbank’s policy line avoiding to support the real economy to grow.

Cheaper money for growth

Berlin insists that ECB has only one mandate to serve: to keep inflation at bay. Nowadays though, Eurozone’s problem is exactly the opposite; very low inflation, falling short from ECB’s target set at bellow but close to 2%. In October Eurozone inflation fell to 0.7% and seems to have gained two decimal points in November at 0.9%. ECB’s economists predict even less inflation next year. According to Draghi, “Eurosystem staff macroeconomic projections for the euro area foresee annual Harmonised Index of Consumer Prices (HICP) inflation at 1.4% in 2013, at 1.1% in 2014 and at 1.3% in 2015. In comparison with the September 2013 ECB staff macroeconomic projections, the projection for inflation for 2013 has been revised downwards by 0.1 percentage point and for 2014 it has been revised downwards by 0.2 percentage point”.

It’s more than certain then that inflation will continue to remain at subdued levels all along the next two years. If this will be the case, ECB’s interest rates will remain at its present (0.25%) or even lower rates. Judging Draghi from his decisiveness last month to lower the cost of money to near zero levels, despite the strong opposition from Germany, if need appears, he will manage to secure a majority in the Governing Council for zero interest rates. Probably he will not hesitate even to reduce the bank deposit facility rate from presently zero to negative levels. This last rate is the interest banks get when depositing their money with the ECB. Not to forget that the central bank is the bank of banks.

All in all Draghi will long to increasingly employ the monetary policy to support the real economy and more so in the worst hit countries, despite what Germany says.






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