The man who saved the euro bows out amid ‘unprecedented’ dissent at Europe’s central bank

In the final weeks of Mario Draghi’s tenure as president of the European Central Bank, the challenges awaiting his successor, Christine Lagarde, have become increasingly clear.

The ECB, which held the final policy meeting led by Draghi on Thursday, is sharply divided over its move to reopen the stimulus taps last month. European governments look no closer to heeding his call for fiscal stimulus that could ease the burden on the central bank. And Europe’s sluggish economy continues to face serious risks.

Lagarde, who attended Thursday’s meeting and takes over on November 1, may be well suited to these tough circumstances. The former International Monetary Fund chief and French finance minister is known for her political acumen — skills that could help reduce dissent within the central bank and convince governments to act. But that doesn’t mean her success is guaranteed.

‘Unprecedented’ infighting

Draghi announced last month that the ECB would respond to weaker growth and inflation by pushing interest rates further into negative territory and restarting its bond-buying program, known as quantitative easing (QE). For the man widely credited with saving the euro by promising to do “whatever it takes” at the peak of the region’s debt crisis in 2012, it was a fitting swan song.

With major action already taken, Lagarde will have some time to get used to the job. However, Draghi’s parting shot has burst open longstanding divisions on the ECB’s Governing Council, where some members regard the resurrection of QE as a bridge too far.

“The public disagreement among Governing Council members undermines credibility and will challenge Ms. Lagarde from the start,” Bank of America Merrill Lynch analysts said in a recent note.

The minutes of the September meeting showed that a number of members opposed the decision to restart bond purchases, compared to “a very large majority” that approved of the interest rate cut. After the meeting, Klaas Knot, the head of the Netherlands’ central bank and a member of the Governing Council, put out a statement opposing the package as “disproportionate to the present economic conditions.” Germany’s Sabine Lautenschläger, whose term should have run until 2022, resigned before the month was out.

Draghi on Thursday defended the bank’s actions in September as “justified,” pointing to the worrying economic data that had been released since then. He also described a spirit of reconciliation at the October meeting, which he said was characterized by a “general call to unity.”

In reality, reconciliation may not be that easy. Carsten Brzeski, ING’s chief economist in Germany, described the public acrimony around the stimulus package as “unprecedented.” One of Draghi’s accomplishments, Brzeski said, had been getting ECB policymakers to speak with a unified voice.

“In the run-up to a meeting you heard diverging views,” he said. “But once a decision was taken, the dissidents shut up — until the September meeting.”

One factor working in Lagarde’s favor: the German government’s decision this week to appoint Isabel Schnabel as Lautenschläger’s replacement, Brzeski said. While the Germans have typically occupied the hawkish camp at the ECB, Schnabel has historically taken less hardline stances, and could be a “more constructive” voice in the room, he observed.

Weak economy persists

Meanwhile, the region’s economic data remains soft, particularly with regard to manufacturing.

There are some green shoots. The odds that the United Kingdom will crash out of the European Union at the end of this month have decreased, and the United States and China are working toward a “phase one” trade deal that could be signed in November. But the upside for Europe looks limited, not least because of the risks of its own trade war with the United States.

“Uncertainty over trade wars persists, and the minuscule progress on US-China talks is probably offset, from a European perspective, by the intensifying EU-US situation,” the Bank of America Merrill Lynch analysts wrote.

There are also signs that the recession in manufacturing is spilling over to consumers. Should conditions continue to deteriorate, Lagarde’s ECB could find itself in a bind, having already depleted much of its toolkit.

With this in mind, Lagarde is expected to repeat calls for European governments to match monetary action with fiscal stimulus. But significant moves from countries like Germany and the Netherlands look unlikely in the near future.

“This train is moving extremely slowly,” Brzeski said. “These things never go fast in Europe.”

On internal divisions and cajoling governments alike, Lagarde’s political skills could come in handy. Yet the situation in Frankfurt is poised to challenge even the seasoned negotiator.

“As [Draghi] hands over the monetary baton to Christine Lagarde, she might as well use it to beat up finance ministers,” Société Générale strategist Kit Juckes wrote in a note to clients Thursday. “If she can do that, the euro will recover; if she can’t, it is likely to struggle.”