FRANKFURT With some rate-setters advocating immediate policy easing last week, European Central Bank President Mario Draghi struck a compromise to keep the doves on side and set up expectations for action in December, central banking sources said.
Several influential Governing Council members argued that the ECB's balance sheet was still relatively small, especially compared to the U.S. Federal Reserve while Denmark's deeply negative deposit rate illustrated that there was still room to reduce rates, one source with knowledge of the discussion said.
Instead of delivering the wait and see message the market expected, Draghi opted for one that was more dovish and crystal clear, keeping with the ECB's tradition of building a consensus and putting to shame the Fed, which has fumbled with its communication at a critical juncture.
"It needs to be understood: there is consensus at the ECB Governing Council," a rate-setter, who asked not to be named, said. "A move in December is likely."
"Inflation is just not moving higher, there is a risk of falling into a Japanese-style liquidity trap," the Governing Council member said.
With inflation in negative territory, the ECB is far from its target of getting price growth to near 2 percent and its 60 billion euros (43 billion pounds) a month asset buys have proven insufficient as lower energy prices and slower growth in emerging economies have worked against it.
Meeting in Malta, the Governing Council discussed a wide range of possible measures and the general view was that instead of one or the other, a combination may be effective, the sources said.
With the Fed postponing its rate hike, Draghi's comments also had the desired effect of weakening the euro, a key result as the exchange rate is an important channel for policy transmission, another Governing Council member said.
Although increased asset buys could further squeeze liquidity in the market, one source with direct knowledge said concerns over market supplies were overdone as the ECB could move into new instruments and had plenty of room to manoeuvre even with government bonds.
The ECB could consider corporate debt or equities while there was also room to buy more supranational instruments. Sovereign debt was plentiful due to high net issuance and the ECB could always release debt to be held until maturity, the source said.
There is a constraint about having to buy national instruments in proportion to how much share each country has in the ECB, but substitution rules also provide some flexibility.
Still, another insider warned that the market may have overreacted to Draghi's words and waiting until December, when the ECB releases fresh inflation forecasts, was normal.
And with monetary policy already ultra-accommodative, room to do more may be limited.
"It’s hard to do much more monetary stimulus than this," said French Finance Minister Michel Sapin, who has no direct say in policy but who less than a year ago was one of the loudest voices urging the bank to do more.
"Draghi said there is still scope to respond to certain situations if needed, so there is still a possibility to do more but we’ve already come a long way."
The consensus from almost 60 economists in a poll conducted by Reuters after Thursday's meeting shows there is an 80 percent probability of the ECB easing at the next policy review on Dec. 3.
Draghi has been a masterful communicator, repairing the reputation of the ECB, which is run by a 25-member Governing Council that sometimes speaks with as many different voices, leaving the market guessing.
From promising to do "whatever it takes" to save the euro at the height of the bloc's crisis in 2012 to delivering an unexpectedly large 1 trillion euro plus quantitative easing (QE) programme this year, Draghi has become an expert in understanding what the market needs to hear and delivering more.
"The ECB really has become masters of communication: leading the market along, and then over-delivering," UniCredit chief economist Erik Nielsen said in a note. "I think Draghi more or less gave it away on Thursday: QE2 (in size, composition, duration) and (unfortunately) a rate cut. Remember, they are not in the habit of under-delivering."
Draghi's clear stance is now in stark contrast to the Fed, which meets on Tuesday and Wednesday.
Markets have been confused by top Fed officials sending conflicting signals and rate hike expectations have been pushed into next year even as Fed Chair Janet Yellen said she expects that a hike will be needed by the end of this year.
"It is never a good thing when the vice chairman of the FOMC and the vice chairman of the board are saying two different things at a critical juncture for policy," former Fed research director David Stockton said.
"When comparing the communications of Draghi and Yellen, it is important to remember that Draghi has been dealing with a crisis," said Stockton, now with the Peterson Institute for International Economics and Macroeconomic Advisers. "Yellen has been in a much different environment, one in which careful nuance has been more important than dramatic statements."
WORDS NOT ENOUGH
Draghi's problem now is that he must deliver and the entire world will be watching as market moves induced by the ECB reverberate across the globe.
"If you don’t meet words with action, the market backlash could be quite big,” said one Japanese policymaker on condition of anonymity.
The second round of quantitative easing is always less effective than the first one while the consensus in the Governing Council may also be at risk as more easing means lower borrowing costs for governments, which some central bankers see as de facto monetary financing since the ECB is making it cheaper for governments to borrow.
Governments are also not always doing their fair share to boost growth and accommodative policies by the ECB take pressure off governments to enact long-term measures that may be politically costly now but would support growth over the long term.
(Reporting by Frank Siebelt, Balazs Koranyi, and Francesco Canepa in Frankfurt, George Georgiopoulos in Athens, Leigh Thomas in Paris, Howard Schneider in Washington and Leika Kihara in Tokyo; editing by Susan Thomas)