European Central Bank President Mario Draghi (left) arrives ahead of the European Union summit at the EU headquarters in Brussels on Thursday. With Draghi signalling that he’ll override German-led concerns on government bond purchases if needed, ECB is under attack in the country whose DNA inspired it.

Bloomberg

 As Mario Draghi prepares to push the European Central Bank into quantitative easing, he’s counting the cost of alienating its home nation.

With the ECB president signalling that he’ll override German-led concerns on government bond purchases if needed, his institution is under attack in the country whose DNA inspired it. The outrage reflects concern that the Frankfurt-based central bank, which is modelled on the Bundesbank, is taking risks that its forerunner would never tolerate.

The Italian is now pursuing a charm offensive in the euro area’s biggest and most populous economy before the Governing Council’s January 22 meeting to soften the blow as he presses on with stimulus. His challenge is to outflank the Bundesbank without risking a spillover into national politics serious enough to threaten German support for the single currency.

“The ECB has built up enough credibility on its own,” said Holger Schmieding, chief economist at Berenberg Bank in London. “That the Bundesbank may object to sovereign-bond purchases is largely taken for granted by markets. Tacit support from Berlin would neutralise Bundesbank objections in the German public debate.”

The momentum toward QE is building, with more than 90% of economists in Bloomberg’s monthly survey predicting it’ll start in 2015. Euro-area inflation was 0.3% in November, compared with the ECB’s goal of just under 2%, and is poised to turn negative because of a slump in oil prices.

European bond yields have fallen as investors speculate on more stimulus. Italian and Spanish yields extended declines to record lows today after a surprise decision by the Swiss National Bank to introduce a negative deposit rate to defend the franc. Italian 10-year debt was at 1.94% at 11:24am Frankfurt time on Thursday, and the Spanish equivalent was at 1.75%.

Yet Germany isn’t seeing acute economic pressures. The Ifo institute’s gauge of business confidence rose for a second month in December, according to a report on Thursday. A separate indicator this week showed investor sentiment gaining.

In a sign Draghi may be reaching out in Germany, he was due to give a rare interview to Handelsblatt last week, according to the newspaper, though that article has yet to be published. The day after the December 4 policy decision, he called German Finance Minister Wolfgang Schaeuble, according to a person familiar with the conversation, as previously reported by Zeit magazine.

Draghi also occasionally meets German Chancellor Angela Merkel. She’s concerned some countries are using ultra-loose monetary policy to postpone necessary structural reforms, according to a person with direct knowledge of her discussions.

A spokesman for the ECB said the central bank maintains a dialogue with political leaders in all euro-area countries.

Draghi’s path forward leads through a minefield that includes a non-binding opinion by the European Court of Justice on a previous bond-purchase plan due on January 14, and a ruling four to six months later. Two German states hold elections in the first half of 2015, and one party in Merkel’s coalition has raised the stakes with a pledge to oppose government-bond purchases. Draghi said on December 4 that “we don’t need to have unanimity,” signalling he believes he can find consensus without Germany. Executive Board member Benoit Coeure echoed that view in an interview with the Wall Street Journal published yesterday, saying “the more governors standing by this new instrument, the safer you feel.”

Bundesbank President Jens Weidmann, a Governing Council member, has multiple objections to QE. He says more stimulus is not yet needed and would reduce incentives for governments to reform, may transfer risks to taxpayers and contravene a ban on monetary financing. ECB Executive Board member Sabine Lautenschlaeger, his former vice president, holds similar views.

“Markets at some point have to learn that not every expectation, not every wish, will be fulfilled,” Weidmann said on December 15.

This isn’t Germany’s first disagreement with the ECB. Bundesbank President Axel Weber and Executive Board member Juergen Stark both quit in 2011 in protest against a bond-buying plan by then-President Jean-Claude Trichet.

In a spat early in his tenure, Draghi’s strategy was similar to Thursday’s. Before announcing a plan in 2012 to buy the debt of stressed nations if needed, he spoke with Merkel to garner political support. He later explained his policies to German lawmakers and addressed the nation in a rare television interview in 2013. The plan was never enacted because the European debt crisis subsided.

“Draghi turned market confidence around at the height of the euro crisis by convincing investors that the ECB has the political and legal mandate to protect the euro’s unity,” said Lena Komileva, chief economist at G Plus Economics Ltd in London. “He’s aware that the risks of inciting confrontation with Germany and undermining market confidence in the strength of the political union would outweigh the economic benefits of sovereign bond purchases.”

One difference to 2012 is that Merkel’s Christian Democrats are in a grand coalition that may respond more to voter concerns to stem the rise of anti-euro parties. Her Bavarian partners, the Christian Social Union, last week passed a resolution stating the ECB mustn’t become Europe’s “bad bank.”

A government bond-purchase program would “create great aggravation in Germany,” Peter Bofinger, an economic adviser to Merkel, said in an interview this week. “That is dangerous.”

Policy makers have previously sided with Weidmann. Ewald Nowotny backed him in opposing a program to buy asset-backed securities, and a quarter of the Governing Council objected to the wording of Draghi’s introductory statement this month.

 

 

 

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