Dovish Draghi Does Not Mean ECB Would Act Further In September

Selloff of the euro continues after ECB president Mario Draghi’s speech last week signaled a change in the central bank rhetoric, fueling speculations that the central bank would push forward its QE schedule. While raising concerns over the worsening inflation expectations in the medium term, the president also focused on unemployment. He also urged for actions on ‘both sides of the economy, suggesting deepening of fiscal coordination and speeding up structural reforms, in accompaniment with accommodative monetary policy. Despite Draghi’s dovish comments, we doubt how many of the members shared his views. Meanwhile, with the TLTROs and ABS purchased not yet started, we do not see high possibility that the ECB would accelerate QE measures in coming months.

Draghi warned in his speech that medium-term inflation expectations have deteriorated. Citing the decline in the 5y5y inflation swap rate to below 2%, the president noted that ‘the Governing Council will acknowledge these developments and within its mandate will use all the available instruments needed to ensure price stability over the medium-term’. We noticed that such comments did not exist in his script, signaling the president’s concerns over the issue. In-depth analysis was made regarding the 18-nation region’s labor market condition. According to Draghi, unemployment has been caused by ‘a large and particularly sustained negative shock to GDP’ due first to the Great Recession and then to sovereign debt crisis that followed. He concluded that the high level in unemployment is driven by structural and cyclical factors, and thus only ‘action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies’ could help reverse the current scenario.

ECB’s monetary policy ‘can and should play a central role’ on the demand side. Draghi reiterated the package announced in June should help boost demand. The central bank would continue to ‘stand ready to adjust our policy stance further’, including unrolling unconventional instruments to ‘safeguard the firm anchoring of inflation expectations over the medium- to long –term’. Besides, the ECB called for more actions from the fiscal front. Noting the ‘overall fiscal stance of the euro area’, the president urged for more fiscal coordination is needed and subtly suggested that countries, in particular Germany, might run a more expansionary policy. On the supply side, Draghi suggested to put special focus on’skill intensity’ to boost productivity and long-term growth.

Draghi’s change of tone, getting more dovish, clearly thrilled the market, sending the single currency lower for 4 consecutive days. Bond yields were lower while stocks rallied. The key reason for the market movement was heightened expectations of ECB’s QE. In our opinion, Draghi’s speech may not signal a change in ECB’s decision making. As we mentioned above, the president comments over worsening inflation expected were his improvisation. Therefore, his views may not be widely shared by other members. Moreover, the first auction of TLTROs announced in June would begin in September while the work on ABS purchases remains in progress. We believe the former would help the hawks support postponing further actions while the latter would be the first action to be taken if the ECB needs to act further.

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