The Eurozone needs a pay raise and it needs fiscal stimulus, but the economy hasn't weakened enough to warrant the European Central Bank using up any more of its fast-dwindling stock of ammunition.
That was the message from ECB President Mario Draghi's press conference Thursday after the Frankfurt-based institution left its official interest rates and its quantitative easing program unchanged at the first policy-making meeting since the summer recess.
Draghi said the economy has withstood the shock of Britain's vote to leave the EU, but is still exposed to downside risks, and he repeated that other areas of policy--both at national government and at EU level--must contribute "much more decisively" if the stimulus from the ECB's ultra-loose policy stance is to have its full effect. (To see Draghi's prepared remarks, click here.)
The signs are that record-low interest rates and voracious bond-buying haven't had much effect so far: Eurozone growth slowed to 0.3% in the second quarter, from 0.5% in the first quarter, and data this week out of Germany suggest that the Eurozone's economic engine slowed down even further in July. Draghi said the ECB hadn't markedly upgraded its forecasts for either growth or inflation over the next two years in this week's quarterly update.
Last week, the ECB's bond-buying program passed the milestone of 1 trillion euros. That has driven yields on government and corporate debt down to record levels--enraging German savers, banks and insurers in the process--with only modest success in stimulating investment. Bank lending to corporates rose to a two-year high in July, but was still up only 1.9% year-on-year.
Market commentators have warned that the ECB may run out of bonds to buy before it gets inflation back on track: all German government bonds with less than eight years to run have yields below the ECB's -0.4% discount rate, making them ineligible for purchase. Draghi appeared to admit that this was causing problems, saying that the ECB had set up a committee to ensure that its policy could be implemented smoothly.
"This was a clear hint that the ECB will announce technical changes to its QE purchases at the October meeting, which is a prerequisite to any extension of QE beyond March 2017," said ING Diba chief economist Carsten Brzeski in Frankfurt.
The ECB is currently buying 80 billion euros ($90 billion) a month in government and corporate (but not bank) bonds in order to boost the money supply and depress market interest rates, until March next year at the earliest. The bank repeated its guidance Thursday that it expects interest rates to stay "at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases," a formulation that rules out any increase in rates for nearly a year and leaves the door open to even more rate cuts.
The ECB's stance contrasts with that of the Federal Reserve, which is trying to bring interest rates back to a more normal level after nearly a decade of ultra-loose monetary policy. Soft recent manufacturing and employment data in the U.S. have, however, put even that on the back-burner for now.
There are signs that Draghi may finally get some help from a German government that has focused single-mindedly on balancing the budget since the financial crisis. After years of ignoring Draghi's routine calls for more stimulus, German Finance Minister Wolfgang Schäuble this week said he could cut taxes in the Eurozone's largest economy by up to 17 billion euros ($19 billion). This, however, has less to do with Draghi than with the fact that Germany's general election is next September, and the ruling Christian Democrats needed something to distract attention from their drubbing by far-right populists at a regional election last weekend.
Draghi extended his appeals beyond government circles Thursday, calling on employers to do their bit by giving bigger pay raises. Even though Germany has enjoyed record low joblessness for nearly three years, wage growth has stayed anemic, with benchmark settlements this year falling below last year's level.
"Because of oil prices, because of the big slack in the labor market in the last few years, we had low inflation for a long time," Draghi said. "One of the questions that we are asking ourselves is has this (protracted low inflation) filtered through wage negotiations somehow?…If that were true, we would be extremely concerned, and we are monitoring these developments very closely."
For a long time, the ECB's sensitivity to wage inflation has been asymmetrical: it worried about 'second-round effects' when expectations of higher inflation led to higher pay demands from workers; with a few exceptions, it has rarely expressed the same degree of concern about falling prices leading to too-low wage settlements--something that would be evidence of a self-reinforcing deflationary spiral.
"The case for higher wages is unquestionable," Draghi summed up.
The foreign exchange market was still underwhelmed: by 1015 ET, the euro was at $1.1268, compared to $1.286 before the ECB's rates announcement.
The ECB's key deposit rate remains at a record low -0.4%, while its refinancing rate and marginal lending rates are at 0% and 0.25% respectively.