Draghi’s new stimulus plan may include rate cuts, asset buying

Bloomberg

Mario Draghi is set on pushing the limits of the European Central Bank’s (ECB) firepower right up until he leaves office.
With little more than four months to go in his job, the ECB president has all but pledged new stimulus for Europe’s flagging economy that may include both interest-rate cuts and asset purchases. Adding potency to that statement is his declaration that the institution shouldn’t be hemmed in by its rules restricting the room for maneuver.
In response, European bonds enjoyed one of their biggest rallies in recent memory as yields tumbled to record lows across the region. German 10-year rates are now hovering just above the ECB’s minus 0.4 percent deposit rate, while those on French securities dropped below zero for the first time. Traders in money markets are pricing a rate cut by September.
The threat of stimulus succeeded where the ECB failed earlier this month
in placating investors. It prompted inflation expectations to rise and the euro to fall. According to the institution’s former chief economist, that’s because the extent of Draghi’s pledge opens the door to far more powerful policy action than officials had previously signalled was even possible.
“What is very important is the optionality — to make the options more credible,” Peter Praet, who left the ECB at the start of this month, told Bloomberg Television. “I am not sure that markets say you need to act now, but the markets want to be reassured that if the environment doesn’t improve, do you have the necessary tools to do that.”

SUMMER STIMULUS
Three central bank officials, speaking on condition of anonymity, told Bloom-berg that an interest-rate cut is most likely the first response to any slowdown. Commerzbank AG economists see such a move as soon as the next meeting in July, while JPMorgan Chase & Co. anticipates a change in the policy language first, to set up a cut at the following gathering in September.
“The market was really being fairly lazy on pricing in ECB risks because of some sense they were hesitant to use their tools,” said Richard Kelly, head of global strategy at Toronto-Dominion Bank in London. “Draghi had to be even more blunt that they will act if they feel it is needed.”
That message led Austria and Sweden bonds to join Germany in the club of nations where investors have to pay to hold their sovereign debt. In Italy, investors brushed off comments from Deputy Prime Minister Matteo Salvini that the government would back so-called mini-bills, seen by many as a step toward a parallel currency to the euro, scooping up its bonds on the prospect of fresh quantitative easing. Yields fell the most in a year. The ECB president’s remarks also incited a response from US President Donald Trump, who said the drop in the euro prompted by Draghi’s remarks is unfair.
Draghi responded to that by telling the ECB’s annual retreat in Portugal that “we don’t target the exchange rate — keep this in mind.”
His remarks bring the institution closer to the global easing shift that some economists and investors also expect the Federal Reserve to join this year. US policy makers are seen unlikely to act as soon as their meeting this week.
The problem for Draghi is that he has already used up much of the institution’s ammunition. The deposit rate was cut to an unprecedented low of minus 0.4 percent in 2016. Its stimulus program hoovered so many government bonds that it was getting close to the buffers.
The Governing Council capped the amount of sovereign debt the ECB can acquire under QE to ensure it would avoid violating European Union laws prohibiting it from financing governments. It can’t hold more than 33 percent of
a country’s total debt. There’s also a limit on individual issues of as much
as 33 percent if certain
conditions are met.