A day of reckoning for the ECB?

05 March 2019 | Economics

Balazs Koranyi - The European Central Bank has downplayed a global slowdown for months, but it will finally take a tentative step this week to prop up the euro zone economy, signalling fresh stimulus to keep banks lending.

With a global trade war already biting and growth in Germany, the euro zone's powerhouse, stalling, gloom is quickly spreading across the region, leaving the ECB with the task of reviving confidence.

After a decade of fighting crisis, it is a role the ECB is all too familiar with. But it will be tricky, nevertheless.

The central bank just ended an unprecedented stimulus scheme and has already signalled further "normalisation", in the hope of doing away with crisis-era support. But some sort of policy reversal is inevitable.

Exports are waning, Brexit is looming, industrial production is falling and US president Donald Trump is still weighing tariffs on Europe's vast car industry. The ECB is likely to slash its economic forecasts, putting its inflation target out of reach for several years, enough in itself to trigger action.

"A traditional wait-and-see stance runs the risk of unintentional tightening of monetary conditions," ING economist Carsten Brzeski said. "The ECB will have to carefully balance between too-hasty action, which could be perceived as panic, and too much complacency."

NOT ALONE

To be fair, the ECB is not alone. The US Federal Reserve has already changed course, signalling that it would pause rate increases and stop shrinking its balance sheet, a reversal that has fuelled a two-month rally in stock markets.

The ECB's first step will be to offer banks fresh long-term loans, rolling over a similar facility to keep the credit flowing.

But the devil will be in the details, and the ECB is in no hurry to lay all of its cards on the table.

Still hoping the economic slowdown is just temporary and will end by summer, the ECB is only likely to signal this week that support will come, taking some time to work out details. By then it might be clear whether a rebound is underway.

It would also be relatively easy to take a 2019 rate increase off the table. Markets have already pushed expectations for a move into 2020, threatening to make ECB guidance obsolete.

The problem is that any change in the guidance, which sees rates steady through the summer, will reach beyond the term of ECB president Mario Draghi, a potentially contentious move not all policymakers are ready to take.

"One could argue than once forward guidance is the main tool left, unanimity becomes central to maximise the return of that policy tool. The risk is that by waiting for unanimity the de-anchoring of expectations becomes irreversible," Bank of America Merrill Lynch.

UNANIMITY

But unanimity is hard to achieve, given the history of countries like Germany and the Netherlands fighting loose policy. Any significant easing proposal is likely to reopen the rift between the hawks and doves, risking to create distracting noise around policy.

Unprecedented personnel flux could also make it more difficult for the ECB to take big steps. Half its board and over a third of its rate-setting Governing Council get replaced this year.

In itself, that should not have a great impact on policy. But the institution has a record of lining up behind its president, who doesn't just head the bank but is also a top economic policy advocate in key EU meetings.

Still, clarity on who will take over from Draghi is unlikely to come before European elections in late May, raising the risk of policy hesitation at a sensitive time. – Nampa/Reuters

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