Watching Mario Draghi of the European Central Bank give a press conference can be a lot like sitting through the same movie twice: no matter how much you shout at the screen he still does the same things.
Draghi’s ECB on Thursday cut interest rates, taking a key rate to negative levels, and introduced measures to channel €400bn of liquidity to bank lending. The central bank also said, crucially, it will start work on an asset buying plan, holding out the promise of quantitative easing (QE).
This initially won praise for fulfilling market expectations of a big bang to stave off deflation. Or rather to fight “lowflation” as perhaps Draghi would prefer to put it. When asked, again, about the risk of deflation Draghi seemed, well, to be following a script.
“The answer was and still is, by the way, we don’t see deflation. We don’t see that typical feature of a self-fulfilling negative spiral of self-fulfilling expectations.”
Like watching a horror film from the cheap seats, this makes you want to scream “LOOK OUT MARIO, ITS BEHIND YOU! IN PORTUGAL AND GREECE.”
Seriously, I don’t know what Draghi sees but the threat from deflation in Europe is real, and the lack of a clearly observable self-fullfilling spiral, yet, does not obviate that.
Deflation isn’t so much a cliff, but a very steep hill which the further you descend the more likely you are to lose your footing.
The other part of Draghi’s performance, which did manage to drive the euro down by a bit but only for a while, was that he gave tempting hints about preparations for QE which might be used in the future.
The initial preparations are aimed at creating a framework for purchasing asset-backed bonds, a worthy project but one which may have limited scope for being that big bazooka the market wants.
Buying asset backed securities (ABS) makes great sense. It could be a way to channel credit towards eurozone companies bypassing the banks, which because they themselves need to raise capital are unwilling to do much even with ever-more generous dollops of ECB liquidity.
The un-fired gun
I think talking QE without delivering might prove to be a tactical mistake. Indeed the action in currency markets, with the euro falling on the initial news but then climbing higher as the day went on, supports this.
Introducing the idea without putting it into practice is an invitation for traders to wait Draghi out and force his hand, and its also arguably removing focus from the other moves.
Playwright Anton Chekhov had a rule for plots which was that you never introduce a gun on the wall in the first act of a play unless sometime later it is going to go off.
Draghi’s QE will prove to be like Chekhov’s gun. Having spoken of it he will be forced to use it.
The problem, of course, is that the gun Draghi has in mind and the one the markets want are two different things. One is modest and buys ABS. One is massive and buys government bonds, something it is unclear the ECB can or will do.
While encouraging banks to make loans to small and medium sized businesses is all well and good, these same banks are also being hounded, rightly, to raise more capital. Doing both at the same time will be difficult. Cutting interest rates into negative territory is a terrific story, but one which creates a small impact.
At the same time, the whole world knows the ECB wants a lower euro and has introduced the idea of QE, or a sort.
Traders and investors are going to wait for the Draghi to take the QE gun from off the wall.
(The opinions expressed here are those of James Saft, a columnist for Reuters. At the time of publication Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)