It was in the Grand Tetons of Wyoming that Mario Draghi fell out with Angela Merkel.
Last August, the European Central Bank president flew to Jackson Hole for the annual symposium with the world’s other top monetary policy makers. What he told them in his address, delivered over lunch, would mark the start of a sharp deterioration in his relationship with the German chancellor.
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In his speech, crucial parts of which were not shared in advance with the ECB’s inner circle of officials, Mr Draghi laid the groundwork for this week’s launch of a €1tn government bond-buying programme, aspects of which have infuriated the chancellery in Berlin.
The bond between the eurozone’s most powerful political leader and its central bank chief has been crucial to the stability of the eurozone as it navigated its way through debt crises, weak growth and now deflation.
Ms Merkel had offered unequivocal support to Mr Draghi when he promised in the summer of 2012 to do “whatever it takes” to save the currency area from breaking up, including buying troubled sovereigns’ debt in potentially unlimited quantities. But over the past 18 months, Berlin has become increasingly vexed by the ECB’s pursuit of monetary easing.
Ultra-low interest rates have angered German savers, putting pressure on Ms Merkel’s Christian Democratic Union and playing into the hands of the eurosceptic AfD party. Her fallout with the ECB and deep worries about the eurozone economy come on top of the huge pressures of the Ukraine crisis. While Europe’s most powerful leader does not think she has lost control of the EU’s fate, she fears she could.
The ECB president’s suggestion in Jackson Hole that Germany needed to raid its fiscal coffers to boost growth in the region crossed a line with the chancellery, with Ms Merkel saying privately at the time that it was a “game changer”. Mr Draghi added to Berlin’s rancour by being unusually explicit about declining inflation expectations, which for markets effectively made eurozone QE an inevitability.
After a meeting with Mr Draghi on the sidelines of an EU summit in December, the chancellor’s ire was so great that she took soundings about speaking out against QE — a move that would have almost certainly roiled markets which had by then mostly priced in the possibility of sovereign bond buying. However, she did not go public and the chancellery view is that she would never have carried out the threat.
Ms Merkel has been less tight-lipped in private conversations with other eurozone leaders, however.
In London in early January, the chancellor visited an exhibition at the British Museum with prime minister David Cameron. Ms Merkel waited until the two leaders passed exhibits on the Weimar Republic and hyperinflation before turning to Mr Cameron to say she thought QE was a “very, very bad idea”.
The following week, Mr Draghi visited the chancellor and her finance minister, Wolfgang Schäuble. The ECB president was unable to allay their concerns that sovereign bond buying would ease the pressure on spendthrift member states to undertake tough economic reforms, or leave German taxpayers on the hook should other countries renege on their debt obligations. The issue is particularly contentious ahead of Sunday’s Greek election, which the leftwing Syriza party, which is calling for a restructuring of the national debt and an abandonment of austerity, is favourite to win. Its leader, Alexis Tsipras, has met Mr Draghi twice.
The Big Read
The ECB’s debate with Germany threatens to lessen the impact of the expected asset-buying plan
Nor does Berlin buy the argument that the eurozone’s struggle with deflation has dented the ECB’s credibility to meet its price stability target of below but close to 2 per cent. It is also sceptical that the policy will give much of a lift to either inflation or growth.
Over recent months, Mr Draghi has been deeply troubled about the intense criticism from the German political and economic establishment of the ECB’s shift towards more aggressive use of unconventional monetary policy. Some ECB policy makers fear the backlash in Germany could even cancel out some of the boost to public confidence that QE is intended to deliver.
In the end, Mr Draghi knew he had no option but to bow to pressure from Berlin and with the central bank’s tradition of pooling responsibility for losses on its sovereign-bond buying sprees between the eurozone’s 19 national central banks.
Instead the national central banks will take on responsibility for almost all the losses on their sovereign’s debt — a fix designed to prevent the rest of the region from taking a hit on a restructuring of Greek debt, but which has also raised concerns that the ECB is no longer as committed to maintaining the currency union in its current form. The terms of the purchase of Greek bonds under QE were set so that Greece would be unable to participate until June at the earliest.
It was an important concession. But Berlin wanted far more than Mr Draghi provided. It is still worried that the burden might ultimately fall on its taxpayers. The chancellery is particularly indignant about the ECB’s decision to make its programme open-ended, with Mr Draghi committing to buy government bonds until inflation shows signs of heading towards 2 per cent. The feeling is that Mr Draghi has put market concerns ahead of those of his political masters.
“Draghi’s relationship with Berlin will be much more precarious from this point forward. He has put Merkel in a very difficult spot domestically,” said Mujtaba Rahman, director of Eurasia Group. “Her support for earlier ECB decisions has already mobilised anti-euro factions in Germany. She now faces the fallout from QE, alongside difficult negotiations on Greece and Ukraine, ahead of upcoming state elections in Hamburg and Bremen where the AfD looks poised to do well.”
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