Even an erstwhile policy ‘dove’ like Mr Rosengren, president of the Boston Fed, has said that, if the economy proceeds as expected, three rate hikes could be warranted this year. It is worth noting that Mr Rosengren referred to the unwinding of the Fed’s balance sheet, a theme that had been absent from Fed comment for some years past. This might have been no more than a curiosity if Mr Harker, the Philadelphia Fed president, had not returned to the topic within days, saying the Fed needed to start thinking about ending reinvestment of its portfolio as soon as the funds rate hits 100 bps. According to the current expectations of FOMC policymakers regarding increases in the funds rate target, the 100 bps level could be reached well before the end of this year. An end to Fed reinvestment might well result in a steeper yield curve, as central bank buying support for longer-dated Treasuries disappeared.


The ECB’s policy is looking much more fragile than the Fed’s. This year, the euro zone economy may well see a pick-up in inflation towards, and possibly beyond, the central bank’s target, while economic growth remains subdued amidst ample spare capacity. The problem, as ECB policymakers are uncomfortably aware, is that this spare capacity is unlikely to be deployed unless there are radical structural reforms to the economies of some euro zone member-states. The governments of those states have been dragging their feet over reforms. They are less than ever likely to adopt any measures that might be unpopular, in the face of the populist political tide. It is against this background that the minutes of the ECB’s policy council meeting on 7-8 December revealed that ’a few’ members did not support the extension of the ECB’s bond purchase scheme. Mr Weidmann of the Bundesbank has, from time to time, objected to the direction in which Mr Draghi has been taking ECB policy. The wording of the minutes suggests he is no longer alone in his criticism. The objection to Mr Draghi’s strategy of negative short-term interest rates combined with massive central bank bond purchases is that it runs risks of damaging the economy that potentially outweigh any likely gains. Further, monetary stimulus will tend to take the pressure off governments that really need to restructure their economies. Mr Draghi’s followers in the ECB policy council have, in response, argued that the dangers of deflation are so great that extreme measures are necessary.


When consumer prices in many euro zone states were falling as a trend, through much of last year, Mr Draghi had little difficulty defending the ECB’s attempts at monetary stimulation. The situation may well have seemed to call for desperate measures. But already, by the December meeting, the ECB policy council had seen CPI inflation in the euro zone rise from a negative 0.2% in April 2016 to 0.6% in the ‘flash’ reading for November. That somewhat weakened Mr Draghi’s case for more monetary support, though 0.6% was still well short of the central bank’s target of ‘close to, but below, 2%’. Subsequently, the ‘flash’ estimate for CPI inflation showed a further jump in December to 1.1%, not so far below the 1.3% the Eurosystem staff had been forecasting for 2017 as a whole. Mr Draghi said after December’s meeting that he expected the unwinding of last year’s oil price effects to result in a substantial rise in ‘headline’ inflation in December. He will not have been dismayed at that. However, there was also a small uptick in inflation on the ECB’s favoured measure, which excludes energy and unprocessed food, from 0.8% to 0.9%, near the top of the range in which it had fluctuated over the previous year. ECB policymakers are reviewing where the risk lies in their inflation forecast. Mr Hansson, for example, has said that the outlook for euro zone inflation has upside risks relative to the figures presented in the Eurosystem’s forecast.


16 | ADMISI - The Ghost In The Machine | January/February 2017


Mr Draghi is likely to face increasing difficulties in presenting the ECB policy council as united behind continuing the central bank’s ultra-accommodative policy. Whereas investors spent most of 2016H2 musing on how the ECB might expand its stimulus to the euro zone economy, the story in 2017 looks like being quite different. The question now is whether Mr Draghi would be able to hold out for accommodation even if he had a mind to do so.


Stephen Lewis E: stephen.lewis@admisi.com T: +44(0) 20 7716 8256


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