Super Mario to the rescue: The ECB cuts interest rates

November 7, 2013

What else is in Super Mario Draghi's toolkit? (Hannelore Foerster/Bloomberg)

If any other central bank met following a series of economic reports showing low and falling inflation mixed with stagnant growth, then elected to cut interest rates, you would say, "well yeah, of course they did."

But this was the European Central Bank. The hard-line, inflation-phobic, Germany-based institution that sets monetary policy for the 17-nation euro zone and has been reluctant to do anything that might risk even the eensiest bit of inflation. As a refresher, steeper price increases would be very helpful right about now in allowing the imbalances within Europe to right themselves, but instead the continent is getting the opposite. Inflation has been well below the just-below-2-percent target that the central bank aims for.

So it wasn't the fundamentals that made the ECB's rate cut Thursday morning a surprise. Rather, it was the decisiveness and speed with which the bank moved to cut short-term interest rates a quarter point, down to 0.25 percent. Analysts had assigned only perhaps a one-in-four or so chance it would make such a move, and thought it more likely the ECB would drag its feet and wait for more data to prove that Europe is falling into a Japan-style deflation trap.

It was enough to drive the stock market up across Europe and to send the euro down against the dollar, helping reverse a run up over the last couple of months that had endangered the continent's economy.

ECB President Mario Draghi indicated in his news conference following the announcement that while the ECB's governing council agreed on the rightness of easing monetary policy, there was disagreement on the timing. Reading the tea leaves, it seems likely that Draghi himself guided the group toward moving more pro-actively to deal with slumping prices. It has been his modus operandi since taking the helm of the bank in November 2011. Overriding German fears that the Italian-born Draghi would be soft on inflation, he pushed the governing council to cut rates at its first two meetings -- moves that with the benefit of hindsight seem like no-brainers, but seemed controversial at the time.

Rates are now within spitting distance of zero on the continent, though Draghi took pains to emphasize that the bank has further room to cut if circumstances warrant. Still, the big open question for the ECB, as its main interest rate target inches ever closer to the zero lower bound, is what kinds of other tools "Super Mario," as the European media likes to refer to him, might find in his kit.

Draghi dodged a question about whether the ECB would consider quantitative easing, the technique used by the Federal Reserve, Bank of England, and Bank of Japan to try to encourage growth and fight deflation even at a time of zero-interest rates. The strategy would be fraught in Europe, where the idea of the central bank buying government bonds is anathema.

A way around the deeply-held aversion to a central bank buying government bonds (and thus effectively funding the government through money-printing) would be for the ECB to expand its balance sheet by taking on private assets, such as a new round of liquidity infusions into the continent's banks. That may be easier for some of the more hard-line members of the governing council to swallow.

The move Thursday was a sign that whatever the future may hold for Europe, and whatever exact tools the ECB deploys, Mario Draghi isn't going to be passive if the trend toward deflation continues.

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Neil Irwin | November 7, 2013