Features

What Mario Draghi’s legacy move means for markets

Yesterday was Mario Draghi’s last chance to leave a lasting impression on eurozone monetary policy. And that seems to be just what he’s done. John Stepek looks at how it affects the markets.

Mario Draghi, president of the European Central Bank (ECB) © Alex Kraus/Bloomberg via Getty Images

A bit of exciting news before we get started today.

I mentioned in yesterday's email that I was hoping to announce the appearance of a very special guest at the MoneyWeek Wealth Summit on 22 November.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Well, I'm pleased to be able to say that Andy Haldane, the Bank of England's chief economist, will be joining us on the day to discuss, among other things, the future of money.

Given the extremely unusual in many ways unique financial and monetary environment we're living in, the opportunity to hear directly from someone who has been working at the coalface of monetary policy for years is one not to be missed.

Advertisement
Advertisement - Article continues below

Book your ticket now. And if you're a MoneyWeek subscriber, check the latest issue which should be hitting your letter box any minute now for your discount code (it's in the brochure attached to the front cover).

Now to today's topic. Which, coincidentally enough, is all about monetary policy.

Draghi to governments: please spend my money

Yesterday was Mario Draghi's last chance to leave a lasting impact on eurozone monetary policy.

During his time as European Central Bank boss, he managed to convince markets that he wouldn't let the euro implode on his watch. So he can tick that one off as "mission accomplished".

What he had to do yesterday, was to give his incoming successor, Christine Lagarde, as much support as possible to enable her to maintain a "dovish" approach to monetary policy, and resist the more "hawkish" approach favoured by German central bankers and some of their compatriots.

And, to be honest, that seems to be what he's done.

Advertisement
Advertisement - Article continues below

There has been some scepticism from commentators. Draghi cut interest rates from negative 0.4% to negative 0.5%, which was no more than expected. He also restarted quantitative easing (QE), but only at €20bn a month markets had expected €30bn.

However, the devil is in the detail. And the most important detail is that he said that QE will continue until the eurozone's inflation target is met and interest rates start rising. In other words, it's QE for as long as it takes.

Now, some people have argued that this is not as big a deal as it looks. The ECB is only allowed to buy up to 33% of outstanding bonds, and it is likely to hit that ceiling in about a year.

However, with Draghi having set the precedent of ongoing QE, it is very hard to see eurozone central bankers running the risk of stopping it in the future, unless they are very clear that they have achieved their inflation target and that the market won't collapse if they do so.

In effect, he's set monetary policy on autopilot so that Lagarde (who is more politician than central banker) can let QE rumble on and spend the rest of her time trying to convince German politicians to spend more money.

And this really was Draghi's parting message. He said that eurozone banks should stop moaning about negative interest rates and instead build better, more competitive businesses.

Advertisement
Advertisement - Article continues below

And he said that if politicians wanted negative interest rates to end, then they should use more fiscal policy (ie, more government spending), to get their economies moving, which would then put an end to the need for negative rates more quickly.

In effect, he's practically begging them to take that €20bn a month and spend it on something.

Central banks can't do what they're being asked to do

You may or may not agree with any of these moves.

For my part, I've probably made this clear in the past, but I think that the way our entire financial system has become geared to the decisions of central banks is incredibly unhealthy and is undermining the efficient allocation of capital, which is the whole point of a free market system.

It's also increasingly hard to see what we're trying to achieve with current monetary policy. Central banks are being asked to fix problems that they really can't do anything about.

The eurozone's problems are structural it's a half-finished project that doesn't have the political backing to do what's necessary to reach the end stage. Draghi can patch over that but he can't fix it.

Advertisement
Advertisement - Article continues below

However, no one is ready to face up to that as yet. So Draghi is the only show in town. And if you want to know if his approach worked or not, then I said yesterday that the market reaction is probably the thing to watch. And so far the reaction suggests that Draghi's plan has indeed worked, at least for now.

I noted that we'd be looking for a rise in eurozone banking stocks (which have been the epicentre of recent market deflation fear), and a bounce in the euro (this is counterintuitive you'd normally expect looser monetary policy to weaken the currency but I'd suggest in this case it's indicative of confidence that Draghi has managed to push back a potential blow up once again).

So far, eurozone bank stocks have ticked higher, as has the euro.

How long will this added confidence boost last? It's hard to say. But if markets believe that Draghi has done enough to underwrite the eurozone system (again), and to prevent the hawks from taking over once he steps down, then it's possible that this could mark a turning point and that the market's fear of deflation will once again start to reverse.

Advertisement

Recommended

Visit/519858/how-long-can-the-good-times-roll
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Visit/investments/bonds/government-bonds/600738/keep-an-eye-on-swedens-interest-rates
Government bonds

Keep an eye on Sweden's interest rates

Could Sweden be poised to return to negative interest rates?
31 Jan 2020
Visit/economy/uk-economy/brexit/600739/boris-johnsons-big-brexit-plan
Brexit

Boris Johnson’s big Brexit plan

The prime minister needs to get Brexit done, and get the economy growing – particularly for first-time Tory voters. Can he manage all that while negot…
30 Jan 2020
Visit/520380/investors-neednt-fear-the-rise-of-europes-green-parties
EU Economy

Investors needn’t fear the rise of Europe’s green parties

Green parties across Europe are finding the centre-right to be natural allies. That will be great for business, says Matthew Lynn.
12 Jan 2020

Most Popular

Visit/investments/stocks-and-shares/600863/sirius-minerals-anglo-american-takeover
Stocks and shares

Do you own shares in Sirius Minerals? Here’s what you need to do now

Mining giant Anglo American has proposed a cash takeover of Yorkshire-based minnow Sirius Minerals. Unhappy shareholders must decide whether to accept…
20 Feb 2020
Visit/currencies/600842/eur-usd-euro-slide-against-us-dollar
Currencies

The euro’s slide against the US dollar looks set to continue

The euro has been in a bear market against the US dollar for two years now. And on a broader scale since 2008. A decline like that is telling us somet…
19 Feb 2020
Visit/economy/uk-economy/600862/britains-economy-might-spring-a-surprise-on-the-doomsayers-this-year
UK Economy

Britain’s economy might spring a surprise on the doomsayers this year

The UK economy is looking pretty good – we’re more at risk of a boom than a bust, says John Stepek. Here’s why, and what it means for your portfolio.
20 Feb 2020
Visit/517625/tr-european-growth-trust-why-investors-shouldnt-overlook-europe
Sponsored

Why investors shouldn’t overlook Europe

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, tackles investor questions around Europe’s economic outlook and the conseq…
6 Nov 2019