While central banks in the U.S. and Japan are struggling with the consequences of their non-conventional policies, President of the European Central Bank Mario Draghi proudly promotes his institution’s more conservative approach. During the press conference following the governing council’s meeting on Thursday June 6th, Draghi staunchly defended his actions: “The ECB hasn’t done anything to increase volatility in the markets,” he said, indirectly pointing the finger at Japan and the Federal Reserve. He even stressed that the ECB is managing to shrink its balance sheet without causing the kind of widespread anxiety among investors that is currently affecting financial markets. Draghi did not announce any new policies or interest rate cuts. For now, the ECB seems to be in a holding pattern, for multiple reasons:

  • More recent data do not support new action, as the economic situation in Europe is not getting worse—though it is not getting better either. Draghi admits that the credit crunch is still harming small- and medium-sized enterprises in many euro zone countries, but according to him trying to reactivate credit channels through some form of securitization of bank loans to SME’s is a medium- to long-term project. Also, the ECB is technically prepared to impose negative deposit rates. Yet such a step would carry unintended consequences, i.e. it would probably not enhance credit flows, but most certainly would have an impact on foreign currency markets as it did in Denmark. For now the tool stays where it is: on the shelf.
  • The ECB is mindful of the fact that the German Constitutional Court in Karlsruhe will hold hearings on the European Stability Mechanism and the ECB’s bond buying program next week. Why rock the boat now? Draghi defended the bond-buying program known as Outright Monetary Transactions (OMT) as one of the most brilliant moves in recent central bank history. He then proceeded to list all the benefits it had for global financial stability, but conveniently failed to mention the fact that OMT eliminated a possible default of one or more members of the euro area, something critics of the program contend should not be the ECB’s responsibility. Draghi is clearly worried about the hearings in Karlsruhe but is understandably trying to keep his cool.
  • The ECB is also playing a new hand of poker with European politicians. The central bank will not move unless politicians make substantial progress on the banking union. Such progress includes the need to create a credible financial backstop for the ambitious asset quality review of banks that the ECB will initiate later this year. This applies to all those financial institutions that will come e under direct ECB supervision in 2014.. The financial backstop could be necessary to recapitalize banks should they be unable to cover capital shortfalls on their own. “We want to make sure there is an explicit commitment by the government, the ESM (European Stability Mechanism), and the Eurogroup,” Draghi said. In other words, if political leaders really want to make progress on the banking union, they will soon have the chance to demonstrate that they are serious about it.

Last but not least, the ECB would like to see more decisive action by member governments on structural reforms. In a veiled warning to countries such as France, Draghi pointed out that getting more time from the EU Commission to achieve fiscal deficit targets only makes sense if those governments create the conditions for their economies to regain competiveness. It is not the first time that the central banker has had to remind politicians of their duties. It certainly will not be the last time either.

  • K Bledowski

    Credit crunch is the most immediate challenge for the ECB.

    True, engaging in massive purchases of securitized loans is not in the cards. But banks are not lending and that’s the problem. They’re not lending because their financial condition has deteriorated. It doesn’t help that new, tougher capital requirements are creeping in. So, cleaning up banks’ balance sheets is key to restoring credit flows. The banking union should help but it’s uncertain what this “union” will eventually look like. Neither the ECB nor the EU Council seems to be in the know what’s desirable and what’s feasible. In the meantime, no government (except perhaps in Ireland and the UK) appears worried about health of its financial sector, let alone is taking any quick steps to support it.

    Europe’s banking sector is still in parlous shape yet supervisors, politicians, and even national central banks remain sanguine about it. It’s no wonder then that the ECB is not stepping into the fray.