Draghi’s speech marks a turning point in ECB rhetoric

Mario Draghi called for action on both demand- and supply-side policies and urged European governments to deepen fiscal coordination and speed up structural reforms. But what is more important, he mentioned explicitly the recent decline in medium-term inflation expectations as a source of concern for the ECB’s Governing Council, which Barclays analysts believe could require additional easing measures, as most investors expect.

However, which really marks a turning point in the official language of the ECB, is that the current situation requires action on “both sides of the economy” (demand and supply).

 

Monetary policy to the rescue of aggregate demand

For the first time, ECB president referred to the need of boosting aggregate demand. “He noted that the ECB has its part to play, which was the purpose of the measures announced in June and currently being deployed. In particular, he indicated that the preparation for outright purchases in ABS markets is ‘fast moving forward’. Given the recent renewed weakness in economic activity and the ongoing decline in medium-term inflation expectations (Draghi explicitly mentioned the decline in the 5y5y inflation swap rate below 2%), he indicated that the Governing Council would “acknowledge” this development and opened the door for additional measures.”

“However, we still believe that the Governing Council will put the focus on the measures announced in June (including the ABS purchase programme), and we do not expect any further announcement before year-end.”

Significant shift regarding the role of fiscal policy

President Draghi clearly called for fiscal policies to also play a role in boosting aggregate demand, which means that Draghi would be supporting the view of France and Italy of using the margin of flexibility enshrined in the Stability and Growth Pact to take stock of the economic weakness and “make room for the cost of needed structural reforms”.

Moreover, Mario Draghi mentioned for the first time the “overall fiscal stance of the euro area.”

According to Barclays experts, “this is a major breakthrough: explicitly, it supports the view that more fiscal coordination is needed; implicitly, it means that some countries could run a more expansionary policy (in particular Germany). Last but not least, he made his the idea of a euro area budget to finance a large public investment programme.

Therefore, we fully agree with President Draghi that supporting public investment should be a priority and would be probably more efficient at the aggregate European level, given budget constraints in some member states.”

Structural reforms more urgent than ever

“Regarding the supply side, ECB President Draghi has reiterated his call for more action by national governments, in particular on labour market policies: more flexibility is needed to better align wages and productivity, and a special focus must be put on ‘skill intensity’ to boost productivity and long-term growth.”

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