Draghi keeps the euro cheap, helps debt refinancing, recapitalization of banks and growth

European Central Bank Press Conference – 14 December 2017. Mario Draghi, President of ECB (in the middle) and Vítor Constâncio, Vice-President of ECB (on the right), walk towards the Conference room. (ECB audiovisual services, some rights reserved).

Last Thursday, the European Central Bank decided to keep flooding the Eurozone with hundreds of billions, despite strong objections coming from the frugal German-Dutch duo. Mario Draghi was adamant about that. It’s interesting to follow his response to a journalist’s remark, who reminded him that the “Dutch Central Bank President Klaas Knot said in a speech late November that the asset purchase program has run its course”. Draghi didn’t hesitate and swiftly answered, “As regards your first point that is not the view of the Governing Council”. Clearly, the Dutch central banker had expressed his negative views about the extraordinarily generous monetary policy, but he didn’t convince the majority of the Council.

Last week, however, it was not only the Dutch central banker who had reservations about ECB’s continued money printing. Again, it was a journalist who pointed out to Draghi that “some of your colleagues – like Mr Coeuré or Mr Weidmann or Mr Knot – have expressed confidence that the asset purchases will end in September; do you share their view?” Again, Draghi was unwavering: “We didn’t discuss this today, by the way, but the last discussion we had a month-and-a-half ago showed that the Governing Council, its vast majority, wants to keep, to retain the open-endedness feature of the asset purchase program (APP) as it’s been designed in the last monetary policy council”.

Keeps printing cheap euros

The ECB under APP has so far printed and spent €2.5 trillion, in buying government and corporate bonds mainly in the secondary markets. A month-and-a-half ago, the bank’s Governing Council decided to continue this net asset purchases under APP, at a monthly pace of €30 billion, until the end of September 2018. At that time, ECB had also decided to continue this program beyond September 2018, “if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim”.

Alongside more money printing, the ECB keeps its main interest rate fixed at zero. In relation to that, the central bank’s Governing Council has also clarified it “expects the key ECB interest rates to remain at their present levels (n.b. zero) for an extended period of time, and well past the horizon of the net asset purchases (September 2018)”.

Extraordinarily accommodating

Not without reason then market commentators have termed these ECB measures as ‘extraordinarily accommodating’. Of course, the term accommodating refers to the real economy, but in fact monetary policy is realized through banks. So, in the foreseeable future, the ECB plans to continue refinancing the banks at zero interest rates. It will also keep offering them €30bn a month through purchases of bonds the lenders keep in their vaults, and all that at least until next September (and if necessary beyond). Theoretically, ECB’s ‘money for free’ for the banks has helped the real Eurozone economy to recover and grow for a third year in a row.

In practice though, this policy primarily helps the banks to recapitalize themselves, since they are still dangerously underfunded and the capital markets have definitively denied undertaking that task, on a healthy risk/return bases. So, the ECB extraordinary money printing and handing billions to banks, primarily helps Eurozone’s banking system recover. If this policy has helped the real economy to recover is questionable. Draghi says it did. He has more goals to serve though with this unprecedented monetary policy. Those are the easier and cheaper refinancing of the over indebted member states of Eurozone as well as keeping the euro/dollar parity at bay.

The three targets

The entire Southern region of euro area, comprising Italy, Greece, Spain, Portugal and also Ireland and why not France, would have had difficulties in refinancing their public debts hadn’t the ECB insisted on this ‘free money’ policy. However, Germany and Holland, as the only surplus countries, would have preferred the opposite. That is a policy of higher interest rates, for their hoarded deposits, to produce higher returns. Instead, the ECB has chosen a policy of plenty and zero cost money, on the right assumption that the refinancing of public debt at a reasonable cost and the recapitalization of the lenders should be the prime targets. It’s not only that. There is a third, equally important goal.

More printing of zero interest rate yielding euros also keeps the single money’s parity with the dollar at bay. To be reminded, the euro/dollar rate in the more distant past had oscillated in the expensive region of 1.65 to 1.40. Over the recently past years, however, this rate has dropped to 110 -120 American cents. Obviously, a cheaper euro helps Eurozone’s weaker economies to export more and thus grow faster. On the other side of the fence is again the German export machine which doesn’t need a very cheap euro to function well. On top of that, Germany’s accumulated reserves of more than a trillion would have valued more in dollar terms at a higher parity. Yet, the ECB has to cater for the more pressing Eurozone needs and this is not going to change.

This is the least Germany can accept to keep Eurozone in one piece, since her total rejection of the issuance of a Eurobond or the appointment of a European Minister of Finance, echoes loudly and negatively all over Europe.