European Central Bank (ECB) president Mario Draghi speaking during the bank’s monthly news conference in Frankfurt. Photo: Ralph Orlowski/ReutersEuropean Central Bank (ECB) president Mario Draghi speaking during the bank’s monthly news conference in Frankfurt. Photo: Ralph Orlowski/Reuters

Prodding governments to do more to boost demand and hinting at European Central Bank action to go along with it marks a major shift in ECB chief Mario Draghi’s eurozone policy away from a focus on austerity towards reviving growth.

In a landmark speech on Friday, the ECB president said it would be “helpful for the overall stance of policy” if fiscal policy could play a greater role alongside the ECB’s monetary policy, adding “and I believe there is scope for this”.

The comments marked an end to the tacit coalition of ECB support in combination with German-style fiscal austerity that has been in place since the outbreak of the eurozone crisis. Draghi is now positioning himself closer to France and Italy.

In effect, Draghi is placing more of an emphasis on fiscal stimulus than austerity.

“It’s an enormous change,” said ING economist Carsten Brzeski.

“It is admitting that the recovery might not come, that the eurozone’s problems go beyond structural reforms and austerity measures. It might be a U-turn for how the ECB looks at fiscal policy but not so much for how it looks at monetary policy.”

The eurozone economy is in danger of slipping again into recession and inflation is barely registering in many places.

This comes after the ECB cut interest rates to record lows, plied banks with cheap funding, offered them a new targeted lending programme beginning in September and said it is ready to do more if needed.

So now Draghi wants governments to do more to boost demand, which has been crimped by belt-tightening in crisis-hit states on the eurozone periphery. The core is also starting to face weakness, with the Ukraine crisis sapping business sentiment.

Highlighting the bloc’s woes, a survey yesterday showed German business morale dropped for a fourth straight month in August. Eurozone inflation data on Friday is expected to slow to 0.3 per cent – far below the ECB just-under-2 per cent goal.

The French government resigned, meanwhile, a day after Economy Minister Arnaud Montebourg called for new economic policies and questioned neighbour Germany’s “obsession” with budgetary rigour.

Draghi also used his speech at the Jackson Hole gathering of central bankers to point out that “financial markets have indicated that inflation expectations exhibited significant declines at all horizons” in August.

He pointed to falls in the so-called five-year, five-year forward break-even rate – the ECB’s preferred measure of the inflation outlook, which measures roughly where investors see five-year inflation rates in five years’ time.

This measure dropped almost 20 basis points in August alone, to last trade at 1.96 per cent. Traders say it is close to its 2010 record lows of around 1.90 per cent.

Berenberg bank economist Christian Schulz described as “ominous” a sentence in the speech in which Draghi said of the shifts in inflation expectations: “The Governing Council will acknowledge these developments and within its mandate will use all the available instruments needed to ensure price stability over the medium term.”

Draghi wants governments to do more to boost demand

This raises the stakes for the Council’s September 4 policy meeting, with financial markets growing more excited about the prospect of the ECB embarking on a policy of quantitative easing (QE) – essentially printing money to buy assets.

An intense policy debate can be expected at the meeting, though it is probably too early for the ECB to embark on QE.

Such an asset-buying plan could weaken the euro further, giving exporters’ an edge. However, opponents of the tool say there is little point in spending billions on bonds to lower their yields slightly when they are already near record lows.

Before embarking on QE, the ECB wants to assess the effectiveness of its new targeted loans, or TLTROs.

The ECB is offering banks a first tranche of the TLTROs on September 18, with a second shot in December and more thereafter. It expects total take-up of €450-€850 billion.

The ECB is also intensifying preparations to buy asset-backed securities (ABS).

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