Draghi and Praet say ECB will continue with QE

The European Central Bank’s (ECB) president and chief economist have both said the institution would continue with its quantitative easing (QE) policy until eurozone inflation showed firmer signs of a recovery.

Draghi reiterated that the ECB had “four criteria to confirm a sustained adjustment” to eurozone inflation. Headline inflation would have to be on a path to just below 2%, and there would need to be “sufficient confidence” that inflation would stabilise around that level, he told an audience in Frankfurt today (April 6).

Inflation would have to be “self-sustained, meaning it will maintain its trajectory even with diminishing support from monetary policy”. The headline inflation rate would also have to be at the target level for the entire eurozone and not for individual countries, Draghi said.

To meet the second condition, inflationary pressures would need to be building in the eurozone, Draghi said. But there was, “so far, scant evidence” of this, he argued. Most of the recent increase in headline inflation had been “driven by its most volatile elements”, with more than 90% of the rise between November 2016 and February 2017 explained by food and energy prices.

“Measures of underlying inflationary dynamics, by contrast, remain subdued,” Draghi argued. The ECB’s Harmonised Index of Consumer Prices minus food and energy “has hovered around 0.9% since mid-2013, and still shows few convincing signs of an upward trend”.

While labour market slack would fall as eurozone unemployment continued to drop, it was “unclear how quickly this will feed through into wage dynamics”, Draghi said. Lags like this meant a recovery in inflation “still depends on the very favourable financing conditions” caused by QE.

ECB chief economist Peter Praet, in a speech also given in Frankfurt, also argued that current eurozone conditions mean QE would have to continue for some time. The ECB has to counteract the effects of a lengthy period of downward pressure on inflation, he said. “The severity and persistence” of shocks in recent years “have forced a particularly bold, persistent and steady-handed approach to monetary policy”, he said.

Both Praet and Draghi stressed that the ECB’s range of unconventional monetary policies were complementary. Praet said he expected the ECB’s policy rate to “remain at present or lower levels for an extended period of time and well past the horizon of our net asset purchases”.

Careful attention had to be paid to the sequencing of changes to forward guidance and to the ECB’s asset purchase programmes, Praet said.

Asset purchases would lose much of their effect, “absent reassurance that policy rates will remain anchored around their lower bound for the entire life of the net purchases”, he argued.

If forward guidance fails to give that reassurance, “the downward impact of purchases on long-term interest rates via compression of term premia will be offset” by an expected “steeper path” in short-term interest rates. The term premium itself might also increase “if the future course of the policy rates becomes more uncertain”, he said.