ECB set to loosen policy to lift sagging economy, inflation | Reuters - Firstpost
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ECB set to loosen policy to lift sagging economy, inflation | Reuters

Updated: Mar 10, 2016 05:30 IST

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FRANKFURT The European Central Bank is set to unveil its second stimulus cocktail in three months on Thursday, spurred by fears that low energy costs are feeding into wages and prices, potentially perpetuating ultra-low inflation.

The euro zone's central bank is widely expected to cut its deposit rate deeper into negative territory and adjust its 1.5 trillion euro asset-buying scheme, hoping to boost prices after inflation dipped back into negative territory last month.

The ECB has little to show for the 700 billion euros it has spent buying government bonds and other assets in the past year, as tumbling raw materials prices blunt the impact of its quantitative easing. That raises the risk that people will lose faith in the bank's commitment to its mandate, dragging down long-term price expectations.

Inflation has been below the ECB's nearly 2 percent target for three years and is likely to remain so for many more.

"The stakes are high at (Thursday's) ECB policy meeting, given the disappointment in December and the fundamental questions now being asked about the efficacy and limits of monetary policy," JPMorgan economist Greg Fuzesi said.

"Crucially, it is no longer just a small minority of ECB governors who regard the remaining policy tools as problematic. Markets have also raised some concerns," Fuzesi added. "This makes it harder for (ECB President Mario) Draghi to regain the kudos he lost in December by simply delivering a big package."

Draghi has already said that acting too soon is better than acting too late, and that the rate meeting needs to recognise that the outlook for growth and inflation have deteriorated.

But with policy already deep in unconventional territory, the ECB has few big guns left and most remaining options risk either negative side effects or potential legal challenges, suggesting the Governing Council will opt for a package of modest measures.


Analysts polled by Reuters expect the ECB to cut its deposit rate to -0.4 percent from -0.3 percent, charging banks more for keeping their cash with the bank overnight. They also see a 60 percent chance the ECB will raise its monthly asset purchases, probably by 10 billion euros to 70 billion euros a month. [nL3N16B2M6]

It could also firm up its forward guidance, drop a self-imposed limit not to buy assets yielding less than its deposit rate and launch a new targeted longer-term refinancing operation, possibly at a negative rate, to help boost lending, growth and eventually inflation.

But more radical ideas, like an even deeper rate cut, a multi-tier deposit rate, or buying non-performing bank loans, are unlikely to gain traction within the diverse 25-member Governing Council that has shunned radical steps in several earlier tweaks of its asset-buying programme.

"It would not make much sense for the ECB to announce a bigger but potentially less effective reduction in the deposit rate," Morgan Stanley economist Elga Bartsch said, referring to worries that a deeper cut might curtail banks lending."Contrary to small country central banks, like the Swiss SNB, the Swedish Riksbank or the Danish National Bank, the ECB's policy actions need to take into account their impact on global currency markets and other large economies."

But policy easing may face less resistance than in December as its rotating voting rights mean several hawks, including Bundesbank President Jens Weidmann, will not get to vote this time.

Releasing fresh inflation and GDP forecasts, the ECB may also take comfort in a relatively benign economic outlook. Growth in 2015 actually beat its expectation, consumption is holding up and German industrial production surged in January.

A rebound in global markets since the lows of January is also a relief for the ECB, easing the need for a big move.

Oil prices LCOc1 are up more than 40 percent from early year lows and iron ore .IO62-CNI=SI has risen 66 percent. Euro zone bank shares are still down 15 percent on the year but they are 20 percent above February lows, suggesting market sentiment has stabilised.

A hint dropped by ECB Vice President Vitor Constancio last month regarding concerns about banking profitability may signal the biggest uncertainty surrounding Thursday's meeting.

Suggesting that the ECB would have to mitigate the effect of further policy easing on bank earnings, as Switzerland and Japan have done, some expect it to address compressed margins, exacerbated by the rout in shares, which raise capital costs.

"The ECB will need to address the risk premia and bank profitability constraints together," Citi said in a note to clients. "It is unlikely they can be solved at once, but steps in that direction need to be signalled or taken."

Relatively stable lending margins and calls by the ECB for banks to fix their business models instead of pointing the finger at the ECB, suggest that action is not imminent, however.

(Editing by Catherine Evans)

This story has not been edited by Firstpost staff and is generated by auto-feed.

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