Mario Draghi’s tenure as president of the European Central Bank is drawing to a close. Appointed at the height of the euro crisis in 2011, his eight-year term expires in a year’s time. For a brief period, especially in 2017, the single currency area appeared to have escaped its woes, allowing the former Italian central banker a calmer end to his office than its tempestuous beginning. But now his final year at the helm of the ECB looks set to be anything but relaxed.
One worry is that the eurozone economy has been losing momentum after growing by 2.4 per cent in 2017. Though a canter rather than a gallop, this was the fastest for a decade. The euro area at last seemed to have put behind it the twin traumas of first the financial crisis that came to a head in 2008, and then the acute phase of the euro crisis in 2010-12. For once the European monetary union could boast higher GDP growth than America.
That bright picture has dimmed this year. Already slowing in the first half of 2018, the eurozone economy grew by a mere 0.2 per cent in the third quarter, a far cry from the 0.7 per cent that it managed in the final three months of 2017. Business surveys such as those of purchasing managers reveal a disappointing start to the fourth quarter, with an ebbing of output growth in October to its lowest for over two years according to IHS Markit, an information provider. Manufacturing is doing especially badly. The eurozone is suffering from lower demand for its exports, stemming from a slowing Chinese economy and trade tensions.
Despite the loss of economic momentum, the ECB is holding firm to the strategy for monetary policy that it set out in June. Speaking at the press conference after its governing council met on 25th October, Draghi reaffirmed that the central bank still anticipated ending quantitative easing—purchasing bonds by creating money—at the end of this year.
That has disappointed those calling for yet another extension of QE, which began in March 2015 and was originally supposed to end in September 2016. Yet even though the purchases (which have already subsided from a torrent of €80bn a month between April 2016 and March 2017 to a current dribble of €15bn a month) will shortly cease, monetary policy will remain extraordinarily lax. The ECB will no longer be adding to its pile of assets but it will keep the stock steady at €2.6 trillion (over double the original planned amount) by reinvesting the proceeds of maturing bonds. And it expects to keep interest rates at their all-time lows, which includes a deposit rate of minus 0.4 per cent—meaning that banks in effect have to pay for leaving money with the ECB—at least through next summer.
“There is a limit to what monetary policy can achieve in any jurisdiction, let alone an ill-constructed currency union”The bigger worry for Draghi is the resurgence of political tensions within the currency union. Another reason why last year went so swimmingly was that in a string of national elections starting in the Netherlands, Europeans did not follow the populist revolt of Britain in the referendum of June 2016. Crucially, the French elected the pro-European Emmanuel Macron as president in May 2017. But the impetus to strengthening the institutional underpinning of the euro area that Macron so confidently hoped to achieve has largely faltered. More important, a populist uprising did shake Italy in March 2018, bringing a coalition government to power this summer which is now embroiled in a conflict with the European Commission over its rule-breaking budget.
For Draghi the Italian standoff must feel like groundhog day. Once again markets are fretting about the eurozone’s third biggest economy laden by public debt (the second highest in the zone after Greece as a share of GDP)—just as they were doing when he took over at the ECB on 1stNovember 2011. Then, Italy appeared close to the brink of being forced out of the currency union as bond yields reached oppressive highs. A change of leadership, replacing the discredited Silvio Berlusconi with a technocratic government led by Mario Monti, was vital in restoring confidence. Seven years later, however, the populist coalition of the League, led by Matteo Salvini, and the Five Star Movement, led by Luigi Di Maio, has adopted a budget that has put it on a collision course not just with the Commission but also with bond markets. The all-important spread between Italian and German 10-year government bond yields has widened to three percentage points.
Draghi’s difficulty is that there is very little that the ECB can do to settle the renewed Italian crisis and the threat that it poses to the monetary union. Extending QE would undoubtedly help. The omnipresence of such a big and persistent purchaser has tamed bond markets over the past three years, providing a vital helping hand to the economies of southern Europe that fared so badly during the crisis. But QE is a monetary policy designed for the euro area as a whole, to combat overly low inflation. If anything, the flare-up in Italian bond markets makes it harder for the ECB to change tack by extending QE into 2019, because it could be interpreted as rewarding an intransigent government.
Draghi does have at his disposal a tool specifically designed to help individual economies under pressure from bond vigilantes. The ECB could deploy the OMT (outright monetary transactions) policy, which gave substance to Draghi’s “whatever it takes” pledge in July 2012 that proved to be the turning point in the euro crisis. OMT allows the central bank to buy if necessary unlimited amounts of sovereign bonds (with a residual maturity of between one and three years) in an economy under siege from the markets. But that as yet unused weapon is subject to a crucial precondition. The country in question must in effect become a ward of court by entering into a special economic and fiscal programme overseen by the euro area’s rescue fund, the European Stability Mechanism. For Italy’s populist coalition government that would be anathema.
More than anyone else, Draghi deserves credit for keeping the euro area intact through proactive policies such as OMT to backstop the single currency and the adoption of QE to resuscitate growth. But there is a limit to what monetary policy can achieve in any jurisdiction, let alone an ill-constructed currency union beset by national tensions between those members that have gained, such as Germany, and those that have lost such as Italy. That is why the re-emergence of the Italian problem makes a sobering backdrop for Draghi’s final year in office.
