Draghi Counts Cost of Outflanking Germany in Stimulus Battle


As Mario Draghi prepares to push the European Central Bank into quantitative easing, he’s counting the cost of alienating its home nation.
With the ECB president signaling that he’ll override German-led concerns on government bond purchases if needed, his institution is under attack in the country whose DNA inspired it. The outrage reflects concern that the Frankfurt-based central bank, which is modeled on the Bundesbank, is taking risks that its forerunner would never tolerate.
The Italian is now pursuing a charm offensive in the euro area’s biggest and most populous economy before the Governing Council’s Jan. 22 meeting to soften the blow as he presses on with stimulus. His challenge is to outflank the Bundesbank without risking a spillover into national politics serious enough to threaten German support for the single currency.
“The ECB has built up enough credibility on its own,” said Holger Schmieding, chief economist at Berenberg Bank in London. “That the Bundesbank may object to sovereign-bond purchases is largely taken for granted by markets. Tacit support from Berlin would neutralize Bundesbank objections in the German public debate.”
The momentum toward QE is building, with more than 90 percent of economists in Bloomberg’s monthly survey predicting it’ll start in 2015. Euro-area inflation was 0.3 percent in November, compared with the ECB’s goal of just under 2 percent, and is poised to turn negative because of a slump in oil prices.

Reaching Out

European bond yields have fallen as investors speculate on more stimulus. Italian and Spanish yields extended declines to record lows today after a surprise decision by the Swiss National Bank to introduce a negative deposit rate to defend the franc. Italian 10-year debt was at 1.94 percent at 2:32 p.m. Frankfurt time, and the Spanish (GSPG10YR) equivalent was at 1.74 percent.
Yet Germany isn’t seeing acute economic pressures. The Ifo institute’s gauge of business confidence rose for a second month in December, according to a report today. A separate indicator this week showed investor sentiment gaining.
In a sign Draghi may be reaching out in Germany, he was due to give a rare interview to Handelsblatt last week, according to the newspaper, though that article has yet to be published. The day after the Dec. 4 policy decision, he called German Finance Minister Wolfgang Schaeuble, according to a person familiar with the conversation, as previously reported by Zeit magazine.

Political Meetings

Draghi also occasionally meets German Chancellor Angela Merkel. She’s concerned some countries are using ultra-loose monetary policy to postpone necessary structural reforms, according to a person with direct knowledge of her discussions.
A spokesman for the ECB said the central bank maintains a dialogue with political leaders in all euro-area countries.
Draghi’s path forward leads through a minefield that includes a non-binding opinion by the European Court of Justice on a previous bond-purchase plan due on Jan. 14, and a ruling four to six months later. Two German states hold elections in the first half of 2015, and one party in Merkel’s coalition has raised the stakes with a pledge to oppose government-bond purchases.
Draghi said on Dec. 4 that “we don’t need to have unanimity,” signaling he believes he can find consensus without Germany. Executive Board member Benoit Coeure echoed that view in an interview with the Wall Street Journal published yesterday, saying “the more governors standing by this new instrument, the safer you feel.”

Multiple Objections

Bundesbank President Jens Weidmann, a Governing Council member, says more stimulus is not yet needed and would reduce incentives for governments to reform, transfer risks to taxpayers and may contravene a ban on monetary financing. ECB Executive Board member Sabine Lautenschlaeger, his former vice president, holds similar views.
“Markets at some point have to learn that not every expectation, not every wish, will be fulfilled,” Weidmann said on Dec. 15.
The president of the German savings banks association said in a Dec. 16 interview in Berlin that he’s skeptical QE will work as intended, and that by entering markets and depressing returns, the central bank effectively masks risk.
“One can then no longer recognize where the difference between a secure asset and a high-risk investment lies,” said Georg Fahrenschon. “Savers will be confronted with the bill.”
This isn’t Germany’s first disagreement with the ECB. Bundesbank President Axel Weber and Executive Board member Juergen Stark both quit in 2011 in protest against a bond-buying plan by then-President Jean-Claude Trichet.
In a spat early in his tenure, Draghi’s strategy was similar to today’s. Before announcing a plan in 2012 to buy the debt of stressed nations if needed, he spoke with Merkel to garner political support. He later explained his policies to German lawmakers and addressed the nation in a rare television interview in 2013. The plan was never enacted because the European debt crisissubsided.

Grand Coalition

“Draghi turned market confidence around at the height of the euro crisis by convincing investors that the ECB has the political and legal mandate to protect the euro’s unity,” said Lena Komileva, chief economist at G Plus Economics Ltd. in London. “He’s aware that the risks of inciting confrontation with Germany and undermining market confidence in the strength of the political union would outweigh the economic benefits of sovereign bond purchases.”
One difference to 2012 is that Merkel’s Christian Democrats are in a grand coalition that may respond more to voter concerns to stem the rise of anti-euro parties. Her Bavarian partners, the Christian Social Union, last week passed a resolution stating the ECB mustn’t become Europe’s “bad bank.”

No Alternative

A government bond-purchase program would “create great aggravation in Germany,” Peter Bofinger, an economic adviser to Merkel, said in an interview this week. “That is dangerous.”
Policy makers have previously sided with Weidmann. Ewald Nowotny backed him in opposing a program to buy asset-backed securities, and a quarter of the Governing Council objected to the wording of Draghi’s introductory statement this month, which strengthened language on plans to boost the ECB’s balance sheet by as much as 1 trillion euros ($1.24 trillion).
Even so, “the Bundesbank is not putting on the table any alternatives to sovereign QE which promise a higher inflation rate for the region” soon enough, said Malcolm Barr, an economist at JPMorgan Chase & Co. in London. “Perhaps this is an argument with the Bundesbank, and German public opinion, that the ECB has to have.”


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