What’s that, you say? The ‘R-word’? Judging from the markets, Mario Draghi’s emphasis on reflation changes everything, and highlights the communications challenge lying ahead of the president of the European Central Bank.
The ECB’s crisis-fighter-in-chief threw investors into a fit of the vapours on Tuesday when he said he was growing increasingly confident in the currency bloc’s economic recovery, and that “deflationary forces have been replaced by reflationary ones”.
The euro leapt more than 1 per cent, reaching above $1.13 against the dollar for the first time since the US elections. Bonds also took a knock, with the yields on benchmark 10-year German Bunds jumping 0.12 percentage points — a decent shift for this market — to a relatively lofty 0.36 per cent, the highest in a month.
This is the Draghi Effect at work. The previous day, new survey data from Germany’s Ifo think-tank showed that business confidence in the region’s economic hub was running at all-time highs. Markets did nothing. Now that Mr Draghi has acknowledged the brighter environment, though, we are off to the races. But is this a serious testing of the waters for starting to withdraw stimulus in the eurozone, or are the markets getting ahead of themselves? Probably a bit of both.
The experience of former Fed chief Ben Bernanke shows that flagging a long-awaited hawkish shift in policy is tricky. His suggestion in May 2013 that the US central bank would start to think about turning off the taps sent the dollar soaring in a move that few would like to repeat. The famously silver-tongued Mr Draghi was nuanced in his message. He suggested that “there are strong grounds for prudence”. Still, as with the US taper tantrum, the direction of travel is clear. “The sheer fact the ECB is becoming less concerned about deflationary pressures could suggest to the market that its next step will be to move away from such accommodative policy,” said analysts at HSBC.
Mr Draghi proved his mettle at keeping investors’ good will and confidence in the depths of the euro crisis, particularly with his much-trumpeted “whatever it takes” catchphrase. Now we will see whether he manages the same trick to smooth out the euro’s almost inevitable ascent.