As if the European Central Bank (ECB) did not have enough to deal with thanks to anaemic growth, high inflation and a sovereign debt crisis, it also has to handle a management succession.
In a little over a month’s time Mario Draghi, currently governor of the Bank of Italy (BoI), will take over as ECB president from Jean-Claude Trichet. A handover that would be fairly standard in business is anything but in the cloak-and-daggers world of eurozone politics.
Draghi was not even first choice for the job: Bundesbank president Axel Weber had been the runaway favourite until he suddenly quit the race to take up an academic post.
Since Germany did not have a strong alternative and it would be politically impossible to give an eight-year term to another Frenchman, the spotlight fell on Draghi. This is hardly surprising given his CV: director-general of the Italian Treasury for 10 years, vice-president of Goldman Sachs for three, and since then head of the BoI and of the Financial Stability Board.
His one “handicap” is not just that he is not German but that he is Italian. “Mamma Mia!” screamed the headline in the German tabloid newspaper Bild when he was tipped for the job. “For Italians, inflation is a way of life, like tomato sauce with spaghetti.”
Since getting the job he has kept his head down, focused on the huge tasks of running Italian national debt and overseeing the root-and-branch reform of the global financial regulatory system. But while he sits in waiting, he must watch Trichet take decisions – or pass on decisions – on interest rates and bond purchases that could determine how his presidency starts.
Robert Mundell, the economist who won a Nobel prize for his work on optimal currency areas, says that Draghi has responded by hemming himself into a corner. “It is difficult because Draghi said in the run-up to his appointment that he would be just as tight as a member of the Bundesbank would be,” he says.
That was a mistake, says Mundell, because while inflation in Germany might have justified the controversial rate rise early this year, “Germany is not the whole union, and the president of the ECB is president of the whole euro area.
“Sometimes you have to have the ECB moving in a slightly different direction than if it was the Bundesbank.”
CUTTING IT
Since then the monetary policy debate has switched from the timing of the next hike to that of the next cut. “Given the risk of economic slowdown and loss of confidence, and that inflation is set to decelerate faster than originally expected when the ECB updated its projections in June, there is room to lower rates,” says Lawrence Boone, European economist at Bank of America Merrill Lynch.
Holger Schmieding, chief economist at Berenberg Bank, adds: “If economic data turn south, Trichet may use his last meeting to preannounce a rate cut so Draghi would not have to do this in November.”
By far the most controversial issue is the strategy that the ECB is taking on its secondary market purchases, its unconventional policy of purchasing troubled governments’ bonds.
Last month’s E42 billion purchases of Italian and Spanish bonds had the “desired effect” of pushing yields back below 5%, according to Jennifer McKeown, senior European economist at Capital Economics in London. But it is still unclear whether the ECB will carry on intervening in the market, to the anger of Germany, or pass the task on to the European Financial Stability Facility, the new rescue body.
Andrew Hilton, director of the Centre for the Study of Financial Innovation and a former World Bank economist, says Trichet has deferred major decisions to ensure he gets to the end of his term with his reputation “unimpaired”.
“You could easily list all the issues that they are going to have to deal with, and all that has happened is action to push the can a little bit further down the road,” he says. “All of these problems will fall to Draghi.”
McKeown says that the ECB’s strategy has already been undermined by Silvio Berlusconi’s decision – since reversed – to water down the austerity budget by dropping a tax on the wealthy. “After all, it only agreed to start buying bonds on the condition that aggressive fiscal tightening would occur,” she says.
Germany is fiercely opposed to the strategy. The normally neutral federal president Christian Wulff used his keynote speech to the 4th Lindau Meeting of Economic Sciences in Germany to describe the purchases as “legally questionable”.
Handling Germany will be a key task for Draghi, especially in the light of the shock resignation of ECB board member Jurgen Stark on September 9.
This leads back to the nationality issue. Myron Scholes, a finance professor at Stanford University, warns that Draghi will find it difficult to help his own country. “It’s easier for Mr Trichet to buy [Italian] bonds than it is for Mr Draghi,” he says. Schmieding says it will be in everyone’s interest to have Italy resolved soon. “Under Draghi the ECB can only be tough on Italy.”
Jan Randolph, director of sovereign risk at IHS Global Insight, says Draghi must be grateful that Trichet took the step of buying Italian bonds. “I know he wanted to cut his own cloth as a central bank manager,” he says. “There has always been suspicion about his Italian background, but he has the right experience and the right skills.”
Hilton downplays the nationality issue, which he sees as a media obsession. “Everyone who knows Draghi says that his heart is German and he is as tough as old boots,” he says.