ECB Rebellion? Draghi's Lost Lieutenants

Three members of Mario Draghi’s inner circle at the European Central Bank oppose his latest moves to position the bank to buy up to €1 trillion in government bonds to rescue Europe from economic stagnation.
Benoit Coeure (middle), usually a loyal ally of Mario Draghi, has joined Sabine Lautenschäger and Yves Mersch in opposition.

Benoit Coeure has long been one of the most soft-spoken members of the European Central Bank and a loyal ally of its president, Mario Draghi.

Last year, the 47-year-old Frenchman was named the ECB’s top diplomat, and he represents the central bank at meetings with European finance ministers and other government officials.

Mr. Coeure is a moderate -- highly regarded by dovish bankers who support a looser monetary policy and hawks such as Jens Weidmann, president of Germany’s Bundesbank.

The Frenchman sides on the bank's executive board more often with his Italian boss than Sabine Lautenschläger, the German board member, or the Luxembourg central banker, Yves Mersch.

That is, until last week.

Central banking sources said Mr. Coeure was one of three members of the six-person board who voted against the bank's move to position itself to buy up to €1 trillion in government bonds in a belated version of quantitative easing to kickstart growth on the Continent.

The 24-member ECB governing council -- which sets interest rates for the euro zone -- includes central bankers from the 18 euro countries as well as the executive board members. Germany’s Börsen Zeitung, a specialty markets publication, first reported Mr. Coeure’s opposition.

Mr. Draghi can still count on the support of a significant majority of the ECB’s governing council. But such dissent on the executive board is more than symbolic.

Mr. Draghi can still count on the support of a significant majority of the ECB’s governing council. Yet such a strong rebellion among the Executive Board is more than a symbolic slap in the face.

The executive board acts as the administrative arm of the ECB – the body that prepares decisions and executes them after the council votes. Mr. Coeure is in charge of both market operations and international relations at the ECB.

Mr. Coeure surely had his reasons for taking the rare step of opposing Mr. Draghi. But his dissent shows just how controversial quantitative easing is for Europe’s central bankers as they come to an ideological fork in the road to economic recovery.

The decision before the ECB is nothing less than whether to launch a large-scale plan to buy government bonds of euro zone countries just like in the United States and Britain, to ignite growth and ward off the threat of deflation.

Mr. Draghi on Thursday suggested the purchase of euro zone government bonds could be launched as early as the first quarter of next year. To his opponents, Mr. Draghi made it clear he would pursue his plan even if the council wasn't unanimously behind him, a rare statement of individual intent from the typically consensus-seeking European panel.

The council's debate on the issue began last Wednesday, 24 hours before Mr. Draghi appeared before reporters and announced the program.

Mr. Coeure and members of the ECB’s economic wing, led by a board member, Peter Praet, discussed the technical feasibility of a quantitative easing plan.

The details are complicated, but important and a major source of disagreement on the council. Unlike central banks in the United States and Britain, which bought their own government bonds, the ECB will have to buy bonds from 18 different governments.

But how much to buy from each euro country? The ECB’s vice president, Vitor Constancio, in a speech last month suggested the ECB would buy bonds by the size of its shareholders – in other words according to the size of the euro zone’s 18 national economies.

That would mean that one in four bonds would be bought in Germany, the ECB’s largest shareholder, where yields on 10-year government bonds are already at an historic low of 0.7 percent, making it the country that arguably needs such a program the least.

Some 20 percent would come from France and 18 percent from Italy.

This was one reason the ECB governing council last Wednesday began looking at other options, according to central banking sources. These options included buying bonds according to the volume of outstanding bonds available in each country.

That would make winners out of completely different countries.

The total volume of outstanding government bonds in Europe is about €8.9 billion. Italian bonds alone make up €2.2 billion of this, or about one quarter. German bonds by contrast make up about 16 percent of the total; French bonds about 22 percent and Spanish bonds 13 percent.

Other options were also presented, such as basing the purchases on the risk-weighting of the bonds of individual countries. Most of these alternative options have one thing in common: They are designed to buy more bonds from struggling euro zone countries - those members that have the highest government debt levels but also need the most help.

These technical details could drastically alter the character of the program. If it aims to boost individual countries, it loses its character as a general monetary policy tool and becomes more of a surgical instrument. But that would also open up the ECB to legal challenges: Under its statute, the central bank is prohibited from directly financing government debt.

There was no final agreement Thursday on the model for European quantitative easing. But Mr. Draghi made clear at last week's meeting that the ECB’s “intended” to increase the size of its balance sheet to levels last seen in early 2012.

That means spending another €1 trillion buying assets, boosting the size from €2 trillion to €3 trillion.

This “intention” effectively commits the ECB to start a quantitative easing plan that includes government bonds. By most measures, there is simply no other way the central bank can reach its new “intention.” No other market that the ECB is engaged in – whether it’s asset-backed securities, covered bonds or long-term bank loans – is large enough.

Mr. Draghi's decision -- which is supported by the majority of euro zone countries, but not Germany -- has opened a rift on the ECB governing council.

Unlike Mr. Weidmann of the German Bundesbank, who opposes quantitative easing in principle, Mr. Coeure is believed to have stated his intention to keep his options open.

Mr. Coeure has supported his president’s intention to strongly boost the size of the ECB’s balance sheet. But sources said he opposes committing the ECB to government bond purchases before there's agreement on how such a plan will be implemented.

For his part, Mr. Draghi never tires of pointing to one key piece of economic data. Annual inflation in the 18-member euro zone stood at 0.3 percent - far below the ECB’s target of close to 2 percent - and could fall down to zero as early as January.

The ECB’s mandate is to close this gap.

Doing anything else would be “illegal,” Mr. Draghi said last week.

This fact has so far kept the ECB governing council mostly in line behind him. Indeed, many members admire Mr. Draghi’s determination. But if there are any more defections such as Mr. Coeure, Mr. Draghi could have a real problem on his hands.

Jens Münchrath leads monetary policy coverage for Handelsblatt. Christopher Cermak also contributed to this story. To contact the author: [email protected]

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