Draghi to hold on zero interest rates until he leaves ECB

ECB Press Conference in Riga, Latvia on 14 June 2018. The new ECB Vice-President Luis de Guindos (on the left), participated for the first time in the customary Press conference after the meeting of the Governing Council. Deputy Governor of the Latvia central bank Zoja Razmusa, in the middle. ECB President Mario Draghi on the right. ECB photo, some rights reserved.

The announcement of the end of the monthly money injections into Eurozone by Mario Draghi, the President of the European Central Bank was not received in the capital markets as a hawkish toughening of monetary policy, as it theoretically should have been. The reasons are many. On the contrary, the euro lost more ground with the dollar – helping exports and impending imports – and euro area shares had a party on Friday, after last Thursday’s Press conference of ECB’s leadership in Riga, Latvia.

This was the result of what Draghi meant as ‘forward guidance’ for investors and markets. He clarified the €2.5 trillion already spinning around will stay there and also that “the interest rate on the main refinancing operations” is to remain at flat zero at least through the summer of 2019. This was enough for markets to celebrate and the euro to soften a bit.

No more money printing

In detail, he signalled that after December 2018 there won’t be any more money printing and spinning, but the ECB will continue “to make net purchases under the asset purchase program (APP) at the current monthly pace of €30 billion until the end of September 2018…. after September 2018, subject to incoming data confirming the Governing Council’s medium-term inflation outlook, the monthly pace of the net asset purchases will be reduced to €15 billion until the end of December 2018 and that net purchases will then end”.

Mind the condition for that: “subject to incoming data confirming the Governing Council’s medium-term inflation outlook”. It means the ECB can keep its money printing machines running even beyond December if inflation wanes further.

In any case, this is the long expected end of money printing and spinning program of the central bank. It goes without saying that the net asset purchases are realized by the ECB with newly printed money, inflating its balance sheet by an equal amount. It’s more than five years now the ECB introduced this extraordinary monetary program of asset purchases.

It has being injecting tens of billions of euro cash every month  into the economy, in order to revive the fading inflation rate and support the real economy grow on zero interest rates. Money printing and zero interest rates have been Draghi’s medicines also for the over-indebted economies of euro area, intending to make ECB’s accommodative policies felt all over Eurozone and not only in the affluent North. So, the heavy debtors in the South can refinance their obligations at low interest rate cost. At the same time though, Germany is on many occasions favored with negative refinancing costs.

Favoring a less pricey euro

By the same token, this accommodative policy, which is about to end – at least theoretically – arrests the long term tendency of the rising euro-dollar parity. It thus helps exports and slows down imports. Still, Berlin has been critical of Draghi’s extraordinary monetary policy from the very beginning in early 2013. Germany especially fought the zero interest rate policy as being the largest ‘moneybag’ of Europe.

Draghi now makes sure that the money which has been printed and distributed so far is to remain there. He said,” the Governing Council intends to maintain its policy of reinvesting the principal payments from maturing securities purchased under the APP” and this “for an extended period of time after the end of the net asset purchases”.

As noted above, this means the €2.5 trillion will stay out there for an indefinite period of time. Add to that the decision for the main ECB’s interest rate – for bank refinancing operations – to remain stuck at a round zero and you come up with a quasi real indefinite continuation of his extraordinarily accommodative monetary policy.

Inflation must revive

It must be stressed that according to Draghi, all decisions signalling the end of new money printing are “subject to incoming data confirming the Governing Council’s medium-term inflation outlook”. That is, if inflation prospects appear weaker, the ECB can reconsider the ending of money printing and starting it again. The target for inflation is close but below 2%.

Dollar interest rates increase

At the same time though, the US central bank, the famous Federal Reserve, follows exactly the opposite policy guidelines. It keeps increasing its main interest rate to arrest possible inflation flare-up. Last Wednesday, 13 June, the Fed increased its main interest rate by a quarter of a percentage unit, for a second time this year. This brings the Fed’s rate range to 1.75% to 2%.

There is more to it though. In comparison to ECB’s decision to keep her own interest rate at zero through the summer of 2019, the Fed left it to be understood there may be two more increases of a quarter of a unit each before the end of this year. As a result, the euro has lost 5.7% with the dollar during the last three months and around 1.5% in one week. This may be considered also an ECB indirect response to the American trade aggression against Europe. Helping euro to devalue is a strong point in a trade feud.

The truth is then that the much anticipated end of ECB’s extraordinary monetary policy is not going to be a fully fledged one. Rather the opposite is true. Obviously, Draghi wishes to continue supporting the South to refinance its debts at low interest costs, at least as long as he is at the helm of ECB until October 2019. His non renewable eight year term ends on 31/10/2019.