FRANKFURT (Reuters) - From his office on the 41st floor of the gleaming new European Central Bank headquarters, Mario Draghi’s view stretches far beyond Frankfurt’s high-rise financial center and he doesn’t like what he sees.
The darkening outlook for the euro zone’s flat and nearly inflation-less economy, exacerbated by tumbling oil prices, is driving him inexorably towards radical action.
Bank on the ECB president to fight the risk of deflation with an expanded program of asset buying early next year, probably in March, despite deep misgivings in Germany’s Bundesbank and from German public opinion.
Draghi has worked for months to build support for what would be the biggest leap in the 15-year-old bank’s history — printing money to buy euro zone sovereign bonds on a large scale, so-called quantitative easing or QE.
Germans are historically allergic to such a policy, which some fear could trigger 1920s-style hyperinflation, create asset price bubbles and give euro zone laggards an excuse to avoid painful economic reforms. Many believe it amounts to illegal financing of governments through the back door.
Draghi confronted such concerns head-on last week, saying that to allow inflation to remain far below the ECB’s target of almost 2 percent would breach its mandate.
“Not to pursue our mandate would be illegal,” he said, turning the legal argument on his German critics.
The bank has just lowered its inflation forecast for next year to 0.7 percent and that did not take account of the latest fall in oil prices.
Rebutting German concerns one by one, Draghi said quantitative easing had proved effective in the United States and Britain, was clearly within the bank’s remit of ensuring price stability and did not require a unanimous decision.
However, the reluctance of the ECB’s biggest shareholder and its allies in the Netherlands, Luxembourg and the Baltics has forced him to move gradually.
The prevailing Anglo-Saxon view is that ECB action, if it comes, will be too late and probably too little.
Draghi’s 2012 pledge to do “whatever it takes” to preserve the euro was a turning point that halted market turmoil during the euro debt crisis, showing the ECB to be the only federal European institution able to act.
But he would have to pledge to buy “however much for however long it takes” to satisfy those critics who believe European-style QE will be too timid and circumscribed.
“Mario Draghi’s penchant for seeking German approval has been his biggest mistake as head of the ECB,” said Christian Odendahl, chief economist at the Centre for European Reform in London. “He should end it. If he waits until the German public comes around to looser ECB policy, it might be too late.”
Draghi has taken interim steps, persuading the Governing Council on which 18 national central bank governors hold a majority, to flood banks with cheap long-term funds for lending, buy bundled business loans and covered bonds.
After Reuters reported criticism of Draghi by some council members, he secured unanimous backing on Nov. 4 to expand the ECB’s balance sheet towards the level it reached at the height of the euro zone debt crisis in 2012 — up to 1 trillion euros higher than today.
Since then, he has kept moving the cursor forward. Last Thursday, Draghi secured agreement to say the bank would alter “early next year the size, pace and composition of our measures” if needed to combat low inflation.
Central bank sources said Bundesbank chief Jens Weidmann and the German member of the ECB’s executive board, Sabine Lautenschlaeger, voted against hardening the reference to expanding the bank’s balance sheet from an “expectation” to an “intention”.
ECB experts say if the bank buys bonds of all its members in the secondary market in proportion to the percentage of each country’s shareholding it should be legally safe.
The fact that French and German bonds, which already have negative real yields, would be the biggest share did not matter, they say, since holders would receive cash that they could invest elsewhere.
With its own economy now gripped by the slowdown and falling inflation, it is harder for Germany to make a case against expanding the ECB’s balance sheet.
Draghi declined to be drawn on how broad a majority he would consider sufficient in the Governing Council to back QE, saying he thought the decision could be framed to win unanimity.
Italian newspapers reported last week’s vote was 18-6 or 17-7 in favor of bolder action.
Draghi is well aware that national central bank governors are influenced by their domestic debates rather than the pan-European view from the 41st floor.
Weidmann and conservative German politicians may feel obliged to represent their constituents by opposing QE, but what matters is whether the Bundesbank would go along with a majority decision or publicly denounce it. The chances of the former are rising as Draghi patiently advances his arguments.
Editing by Mike Peacock/Jeremy Gaunt