What factors impact the timing of when you think the ECB would take action?
Draghi probably wants to do more. Unfortunately, the Governing Council, which dictates ECB policy, is not quite like the Fed, where the chairman dominates decisions if he wants to. The ECB has very significant political constraints. I liken the euro area under Draghi’s leadership to Japan’s under the former head of its central bank.
Before Kuroda came in, the BOJ was led by Shirakawa. Shirakawa increased the size of asset purchases a number of times. But he never really thought it would work—he never raised the BOJ’s own inflation forecast. He never came across as signaling a true regime change.
Along came Kuroda this past April. He announced a huge program. He changed the BOJ’s inflation target. The size of his QQE program was the signal—he said he would do whatever it takes to get 2% inflation, something Shirakawa never did.
The ECB as a central bank does not look and sound like Kuroda leading you to expect it will announce a new higher inflation target, a massive QE program, a signal to the market that the regime has changed, that it is here to play ball and win in a fight against deflationary forces.
They sound more like Shirakawa—we don’t really have a problem, inflation will remain low for a long time, maybe we cut the deposit rate to -10 basis points, while saying early on it won’t have a big effect on the system. If the ECB came out and said we are going to tax you to hold the euro at -150 basis points that would be a big move and change my mind.
But you have all these political forces at work on the Governing Council and different opinions on the cost of inflation. The Bundesbank, the Austrian central bank, the Netherlands prefer price stability, and undershooting the inflation target is not so unattractive to them.
For the weaker southern European central banks—more rightly in my opinion—with as much debt as the euro area has, a faster rate of inflation that keeps nominal gross domestic product (GDP) higher is beneficial. The message we are getting now is there is no consensus in the Governing Council that something needs to be done.
And macro data from the euro area has been coming in OK. Some euro economic indicators are looking outright strong. My sense is, the heart of the Governing Council is not in it for fighting deflation. To change their view, they would need to see collapse in inflation or feel dangerously close to deflation. The only way to get that is if real economic data starts to roll over. Then maybe the ECB starts to sound more Kuroda-esque by the middle of the year.
Conclusion
In summary, Ray’s views are that it is still too early in the U.S. interest rate cycle for the Fed to be a primary determinant of the dollar’s moves—the foreign central banks’ moves are more important today. In that regard, Ray believes it is easier to maintain a bullish dollar position (i.e., assume a weak yen) because of the current account dynamics in Japan and the BOJ’s strong political stance to fight deflation. The ECB is less committed in its effort to promote higher inflation, and the current account dynamics in the euro region make the euro a stronger currency in the absence of more aggressive ECB actions.
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