Draghi's rate cut may really be the last time

German discontent with the European status quo, manifest in Sunday’s dramatic regional election advance for a new right-wing anti-immigration party, further endangers Mario Draghi’s tightrope walk on European Central Bank monetary policy.

Widespread gains in three German states for Alternative für Deutschland, founded just three years ago on an anti-euro platform, mark the biggest breakthrough for Germany’s populist right since the country’s post-second world war democratic rebirth.

Chancellor Angela Merkel has less leeway to defend the ECB president against domestic criticism of unpopular measures on negative interest rates and government bond purchases, seen as undermining savers and monetary soundness.

Merkel’s hold on power looks in no immediate danger. In regional polls that displayed high turnout and widespread voting fragmentation, opponents of her refugee polices within her Christian Democratic Union did badly yesterday. Comforting the chancellor, the Social Democrat party – partners in Merkel’s Berlin coalition but preparing to campaign against her in the 2017 general elections – fared even worse.

Distracted by domestic problems, Merkel will be less able to press home German orthodoxy on European budgetary and macroeconomic policies. This may be a boon for anti-austerity governments across Europe, above all in Paris and Rome, but it undercuts her support from ordinary voters and Germany’s economic elites.

The 10 March widening of the ECB’s unconventional monetary measures, including further reductions in negative interest rates, broadening of monthly bond purchases (now with corporate bonds added) and new cheap loans to banks have, as predicted, unleashed German indignation.

In Sunday’s polls, the AfD won 24% of the vote and came second, behind the CDU, in the depressed eastern region of Saxony-Anhalt, where the radical right has long been active. But it surpassed forecasts, too, in prosperous western Baden-Württemberg and Rhineland-Palatinate, gaining third place in each state with 15% and 13% respectively.

Under fire over her ‘open-door’ policy on immigration, Merkel will be aided by the latest deals with Turkey and restrictive migrant policies in more southerly states in Europe, blocking transit routes into Germany.

Further buttressing Merkel, Winfried Kretschmann, Baden-Württemberg’s Green state premier, one of yesterday’s main victors – who adopts centrist, pro-business polices – vigorously defends the German chancellor’s welcoming stance.

In Rhineland-Palatinate, the incumbent SPD state premier defeated Julia Klöckner, a CDU newcomer previously seen as a potential Merkel successor. Klöckner appeared to fall out of voting favour after opposing Merkel’s refugee management.

After Sunday’s signs of splintering and divisiveness, many will be citing W.B.Yeats’ well-quoted lines: ‘Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world.’

But, with regard to the ECB’s negative interest rates, a more apposite refrain might be from the Rolling Stones: ‘Well I told you once and I told you twice, but you never listen to my advice. You don’t try very hard to please me, with what you know it should be easy. Well, this could be the last time, this could be the last time, maybe the last time, I don’t know.’

Leading ECB council members are putting pressure on Draghi to declare the ECB really has reached the bottom, by formally ruling out any further cuts in negative interest rates, now minus 0.4%. A Draghi statement along these lines at Thursday’s ECB press conference sent the euro higher against the dollar.

As long ago as September 2014, when the ECB reduced negative interest rates to minus 0.2%, Draghi ruled out further interest rate declines, saying, ‘Now we are at the lower bound.’ This time, with support fraying for both his policies and his protector Merkel, it really may be the last time.

David Marsh is Managing Director at OMFIF, where this article was first published.