European Central Bank President Mario Draghi vowed Thursday that the Governing Council was “resolute” in its aim of providing an accommodative monetary policy for the euro area.
Speaking to the media during his regular monthly briefing in Frankfurt, Draghi also said that he and his colleagues were unanimously agreed on the need to use both conventional and non-conventional policy tools – including quantitative easing – in order to defend against both the risk of deflation and a “too prolonged” period of inflation. The ECB kept its key interest rates unchanged for the firth consecutive month Thursday, a decision that was largely in-line with the forecasts of banks and economists.
Draghi said that “all instruments that fall within the mandate [of the ECB], including QE, are intended to be part of this statement. In fact as part of the discussion we had today was a discussion of QE – it was not neglected in the course of what was actually a very rich and ample discussion.”
“We didn’t discuss QE last month. This explains why we discussed it this month, it’s quite obvious that the Governing Council is looking at this period of low inflation and it’s quite obvious that the longer is the period of low inflation, the higher is the risk for inflation expectations in the medium and the longer term,” he continued. “That’s why we discussed and that’s the reason for this statement.”
The preliminary estimate of March inflation, published Monday by Eurostat, showed prices increasing at 0.5% on an annual basis, a figure Draghi called a “surprise” for the Governing Council even as he explained that base effects related to low energy prices and the late 2014 Easter holiday are likely to see prices accelerate in the months ahead.
Draghi once again, however, noted the impact of the strong euro and its impact on area prices and the slowing of Eurozone inflation.
“The exchange rate is very important for price stability so much so that we made an explicit statement in the introductory statement as you see where we say that the governing council sees both upside and downside risk to the outlook for price developments as limited and broadly balanced over the medium term,” he said. “In this context, the possible repercussions of both geopolitical risks and exchange rate developments will be monitored closely.”
“But it is not a policy target, it is an increasingly important factor in our medium term assessment of price stability, but it is not a policy target. In this sense we don’t link our medium term assessment with a precise level of the exchange rate, it’s part of the overall information that comes into play when we do our medium term assessment.”
On the issue of non-standard measures, Draghi said that there was unanimity within the Governing Council but also noted the use of the word “also” in his opening statement, a reference to his earlier allusion to conventional interest rate reductions and the Bank’s continued forward guidance that rates will remain at present or lower levels for a extended period of time.
However, he also explained the difficulty in selecting a particular non-standard tool, noting, in the case of QE, the differences between economies in the United States, which has a capital markets based transmission channel, and that of the euro area, which is far more reliant on a bank-based transmission channel.
“It (QE) is something on which we’ll be thinking hard and reflecting hard but there is a question of how to design QE given that our institutional and financial sector is considerably different from the US, in the US the effect of QE is immediate on all the asset prices. The effect on the term premia is also quite direct because it’s economy based on capital markets. In our case it’s based on bank lending channels and therefore the programme has to be carefully designed to take this element into account.”
Given the Bank’s reluctance to move on rates for the fifth consecutive month, Draghi was asked if its policy of forward guidance was at risk of losing credibility in with the financial markets, a suggestion the ECB President rejected, and in fact described the nearly one-year old policy as “quite successful”, noting developments in market interest rates and the stability they’ve achieved despite actions taken by other central banks.
Leading from this, Draghi was asked about the recent inclusion of unused capacity in the euro area economy in the Governing Council’s statements, first appearing last month and again finding its way into the text again in April, as a component of forward guidance.
“This the new concept that we introduced last time but this time is even more explicit. This reflects the fact that even though we are witnessing improvements, and quite continuous improvements on the real economy, both in hard data and survey data we have evidence that there is plenty of slack in the euro area economy,” Draghi said, noting the difficulty in agreeing a common way of measuring it.
“There are many definitions but all of them are uncertain,” he said. “We see an output gap that is pretty wide and only gradually closes towards the end of our medium-term horizon.”
“That’s why we have to have a growth rate in the coming months higher than potential to close this gap. Low inflation rates do depend on global factors, they do depend on supply factors but they also depend on the weakness of demand where a wide output gap plays a role.”