Super Mario never gives up - good for us!

Timing is everything, as will be known. The best comedians have a unique ability to deliver the final punchline, typically after a brief pause for effect, to increase the tension. It's hard to tell whether Mario Draghi – the current President of the European Central Bank, ECB – had been reading this textbook in the summer of 2012, when he went to London to put an end to the euro crisis. Nonetheless, Draghi took the stage to pronounce the immortal words: "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro." He then paused – and added: "And believe me, it will be enough."

The markets changed course – they had long doubted the ECB’s willingness to ensure stability in the bond markets, and interest rates in the crisis-stricken countries were riding much too high. Shortly afterwards, the ECB announced a programme which explained what would happen, if necessary, but the markets had already put their trust in Draghi – and pushed up interest rates.

In retrospect, Draghi's speech was a vital turning point in the crisis – and Draghi has gained the nickname of "Super Mario". Have we come to another turning point?

The ECB must deliver 2 per cent inflation – which is very difficult.

Draghi's very last sentence at the January meeting of the ECB was "We don't give up", as yet another oneliner for the history books. Then, Draghi was commenting on how the ECB is still much too far from the objective of 2 per cent inflation. At the same press conference, he virtually promised further easing of monetary policy – primarily for two reasons. The euro was stronger, and oil lower, than when the ECB made its inflation forecast in December. This made it even more unlikely that they would be able to fulfil their, already optimistic, forecast.

Two major challenges
Disregarding the lower energy prices, which pull inflation down, however, the ECB basically faces two primary challenges:

The first challenge is that unemployment is much too high, so that wage growth has stagnated at a low level, and in some places is actually still declining. In the USA, they have seen more than six years of growth, and a halving of unemployment, with the lesson that it can be very difficult indeed to push inflation up, when unemployment has been high for a prolonged period.

The second challenge comes from a now sustained period of low inflation – which risks affecting households' and companies' inflation expectations, so that inflation almost risks becoming perpetually self-fulfilling. The conclusion is clear – the ECB has a real struggle to get inflation back to 2 per cent.
 
So far, the ECB has at least been able to indicate sound growth. Unemployment is falling, the banking system is lending money again, and the slowdown in investments is beginning to pick up some momentum.

Warming up for something big
But this is where the good news ends! In contrast to the USA, Euroland has been supported by a weaker currency, more expansionary monetary policy and a lower oil price. The last-mentioned without the same debt concerns as are currently challenging the American banking system. They all share one thing in common – they are temporary. Just as they are temporarily pushing growth down in the USA, they have temporarily pushed growth up in Euroland. When they all diminish in strength, there will be only one thing left to ensure growth – which is the banking system!

The ECB is warming up for something big – and the financial markets will determine how big.

The ECB quite simply has to push the economy as much as it can. This is why already in January they were prepared to ease monetary policy again. Since then, they have been thinking, and the market has already discounted further interest rate reductions by up to 0.3 per cent in the coming quarters. There is a lot of talk about what the ECB will do with their buy-back programme. Will they print even more money? Will they buy other assets than government bonds?

We do not know, but we do expect the ECB to ease again in March. Since we – especially me – were disappointed in December, we are reluctant to increase our expectations too much. Yet the key message from us is a different one. In the current situation, where the banks are under fire from the markets again, and we can see the first small signs of a new banking crisis, our position is very clear: the ECB quite simply cannot allow this.

The ECB is on the optimists' side
One aspect is that we have devoted a lot of time and resources to restoring a banking system that can support growth. The banks have more capital and better liquidity, and are more transparent.

But the current situation is something quite different – if the banks falter again, all hope will be lost of the ECB achieving 2 per cent inflation. So our message is clear – the more the markets stress the banks, the more the ECB will react. The banks are currently severely affected by the low – and negative – interest rates. This damage can be reduced if the ECB introduces a ladder system for deposit interest rates, as in e.g. Denmark and Japan. In rough terms, a limit is set to the deposits with the central bank on which the commercial banks must pay negative interest. The ECB has previously said that this will not be introduced, but the more negative the interest rates become, the more urgent this is. It is vital for us, however, that if the financial markets black out, the ECB will buy corporate bonds, including those issued by banks.

The crisis is not over yet, but the ECB is on our (the optimists') side. They do what it takes  – and never give up!