Mario Draghi can hardly make a move, while Janet Yellen seems bound to do so, no matter the consequences. This summary offers some hindsight on the dilemma facing those at the helm of global financial stability. The ECB will refrain from taking action at today’s Council meeting, counting on the ambitious package it implemented in March to bolster the economy. Any attempt to provide further stimuli could backfire as investors might discount a worse than expected outlook. Not to mention the fact that depleting its meager arsenal with useless salvoes wouldn’t make any sense. All the more so since a potential Brexit could fuel widespread instability, forcing the ECB to use all its remaining firepower.
Draghi must wait for Ms Yellen to make her move. The Fed has expressed its intention of implementing further monetary tightening as soon as mid-June. Even if that claim proves to be ill-timed, the market will force it to honour its pledge earlier than expected. Once the tightening happens, the ECB will be devoid of any arguments for adopting further accommodative moves. The subsequent dollar strength will provide an extra boost for the Eurozone. And the US will never agree to Europe engaging in a crude competitive depreciation, such behaviour only being allowed to happen in ailing Asian countries. A foreign exchange war seems beyond belief on the eve of a US Presidential election.
So Draghi will be on hold for a seemingly extended period. He cannot risk taking hasty action and undermine the ECB’s credibility, his only tangible asset. As rates run close to zero, any liquidity injection could likely lead to full sterilisation, with credit and production remaining largely subdued. Right now, M1 is increasing by a healthy 10%, while broad money is expanding at half that rate. In sharp contrast, credit to the real economy is struggling to get outy of the red, reflecting the failing sentiment the real economy still nurtures. Growth is an unachieved goal, for all the support provided by monetary policy.
The ECB duly kept the European economy afloat when recessionary pressures threatened. Now, it seems powerless to secure a robust and enduring recovery. It’s time to introduce other policies. The Eurozone desperately needs to enhance its financial solidarity. Highly indebted countries cannot cope with this burden, while those enjoying significant room for manoeuvre refrain from expanding domestic demand. Sweeping structural reforms also need to be implemented to upgrade growth potential. An easy-going monetary policy will no longer provide a handy excuse for governments to dodge their responsabilities.