Central Banks

Mario Draghi's legacy will shape the ECB long after his farewell

Key Points
  • Christine Lagarde, the incoming president, will find her hands pretty much tied by Draghi's last big policy package.
  • The ECB's credibility is at risk as inflation, despite all the extraordinary measures, is not moving back to the bank's target. Market-based inflation expectations are close to record lows.
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There is an end to everything: Mario Draghi will leave the European Central Bank (ECB) after eight years in charge of the institution that changed the way monetary policy is conducted in the euro zone.

The ECB moved from being a central bank modeled after the German Bundesbank to a modern, Anglo-Saxon type organization under his reign. The question is, what's next?

Christine Lagarde, the incoming president, will find her hands pretty much tied by Draghi's last big policy package.

"After the Governing Council passed a comprehensive and highly controversial easing package at its 12 September meeting, we expect the ECB policy to be on hold for the remainder of the year and for much if 2020," said Florian Hense from Berenberg in a research note.

"A divided ECB with a new president could maintain its current stance until 2021."

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The ECB's credibility is at risk as inflation, despite all the extraordinary measures, is not moving back to the bank's target. Market-based inflation expectations are close to record lows.

The euro area economy is also in a fragile state: PMI (Purchasing Managers' Index) data has signaled that the manufacturing sector is quickly contracting and that this weakness has started to infect the much larger services sector too.

Much depends on how the trade issue between the U.S. and China plays out and what Brexit will look like in the end.

"Data released since the September meeting signaled a further easing in the underlying momentum of the euro area economy," said Dirk Schumacher at Natixis in a research note.

"We are somewhat more skeptical on the growth outlook, expecting a small contraction of the economy by the end of the year, mostly on the back of Brexit related uncertainty and trade disruptions."

Mario Draghi
Alex Kraus | Bloomberg via Getty Images

The ECB will enter a new era under Lagarde. There is currently much infighting regarding the recent policy decisions, and moving passed this would be crucial for her.

"Lagarde's most pressing job will be to bridge the divisions and ask all Governing Council members to focus on jointly explaining the decision to the public rather than emphasizing the differences," said Hense.

"The planned review of the ECB's monetary policy strategy could be of crucial importance for Lagarde to narrow the divisions within the Governing Council."