On Thursday, December 13, the President of the European Central Bank, Mario Draghi, delivered what should have been a hawkish message to the markets. After years of accommodative central bank policy in the form of negative short-term rates and quantitative easing that went further than the U.S. brand as it included purchasing corporate debt, the leader of the ECB said that QE officially ends with 2018. The end of QE means that artificially low rates further out on the yield curve are coming to an end as the ECB removes its put option and allows market forces to determine medium and longer-term interest rates in Europe.
Draghi explained that underlying strength in the European economy provides policy markers with the confidence that inflation will rise towards their 2 percent target rate. At the same time, there was a contradiction as he said risks are still “broadly balanced” but they are “moving to the downside.”
Moreover, the ECB President said, “QE is part now of the toolbox. It’s permanent; it’s something that may be considered usable in contingencies that the Governing Council will assess in its full independence.” The magician turned what could have been the most hawkish move by the ECB in many years into a continuation of monetary policy accommodation.
The ECB’s balance sheet has swelled by 2.6 trillion euros or $3 trillion. Unlike the U.S. Fed that is now allowing the debt purchases to roll off its books as it comes to maturity, the ECB will reinvest to deliver stimulus during a fragile period of economic expansion. The head of the ECB’s term will expire in October 2019, and his half-hearted move towards tightening credit was little more than handing off the path of accommodation and printing money to the next leader of the central bank.
The euro currency had the most significant reaction to the magic act on Thursday.
As the 10-minute chart of the euro-dollar currency relationship highlights, the European currency moved from $1.1396 to $1.13325 in the wake of the comments. The euro is trading at close to its lowest level of 2018 which was at $1.12455 in mid-November. Based on his comments, it is unlikely that Mario Draghi will ever increase short-term rates from negative forty basis points during his tenure as the head of the central bank.
The U.S. Fed ended their QE program with tapering as they scaled back purchases of debt securities to zero over time. Mario Draghi has chosen to stop cold, with the option to start again. With so many economic and political issues facing Europe from Italian budgets to Brexit, from terrorist attacks in France to a change of leadership in Germany, there are a never-ending set of excuses for accommodation to continue into 2019, 2020, and beyond. There will be a price to pay for the accommodation as easy money policies foster rising debt levels which stoke the inflationary beast. By the time the bill comes due for accommodation in Europe, Mario Draghi will be retired. I wonder if the magician is exchanging euros for gold when it comes to his nest egg and pension.
The path of the euro in the wake of an official announcement about the end European QE in two weeks provided a translation of the central bank President’s comments. The European currency moved lower as Mario Draghi waved a wand and turned a hawk into a dove.