January 27, 2021

The ECB faces the challenge of a possible return to stimuli

The ECB faces the challenge of a possible return to stimuli


The OECD already yesterday advanced a severe reduction of the forecasts of growth for the euro zone, especially cut Germany's expectations to 0.7% of GDP and significantly below the official predictions, which indicates that the ECB Council will be forced to also cut its own forecasts at this Thursday's meeting. The markets also count on, as a consequence, Mario Draghi providing some stronger signal than until now that some new kind of stimulus is on the way, perhaps in the form of cheaper loans, in the hope of avoiding an unexpected slowdown it becomes an economic slowdown. Analysts calculate that the chances of Europe falling into recession, two consecutive quarters of negative growth, are 25%.

With a Brexit that neither backward nor forward and a global trade war marking the economy, business confidence has turned negative, which in turn increases the risk that recession fears come true and spread from Germany and Italy to the rest of the block. Any message of comfort from Draghi will undoubtedly be read as a policy change, since the ECB had ended quantitative easing in December and had announced an increase in interest rates by the end of this year. But central banks around the world are reversing course, led by the US Federal Reserve, which has signaled a pause in interest rate hikes and said it will stop shrinking its balance, which is a big help for investors in the stock market. The ECB, in this same line, could adapt its policy to the deceleration situation and offer banks a new liquidity operation to maintain the flow of credit to corporate borrowers. As for the first rate hikes, the markets do not expect any step in that direction until well into 2020.

In fact, due to the contraction of industrial production and exports, lCommercial banks already seem to be restricting credit, which threatens to reinforce the slowdown. The ECB fears that if banks start to repay loans that come due next year, their balance will contract quickly, which would lead to monetary policy automatically hardening. Much of the slowdown, on the other hand, is imported and therefore is outside the control of the ECB, whose political arsenal is limited, given the long years of stimulus and the rates that are still in a negative territory. "Although the ECB still has some ammunition left, its arsenal lacks easy and free options," warns BNP Paribas in a note to its clients. "Recent data has cast doubt on the ECB's view that the current slowdown is mainly due to temporary factors, which will soon disappear.Indeed, the deterioration in the macroeconomic outlook appears to be longer and longer than the bank central had originally planned, "he stresses.

Today we know without the ECB it remains firm in its thesis, according to which the fall in growth is temporary and many of the culprits will no longer be present in the European economy after the spring. In fact, some recent indicators seem to show timid signs of stabilization, which supports the caution of the ECB. In the new quarterly forecasts, the growth forecast is expected to decrease to 1.3% this year, from the previous 1.8%, and a slight rebound for next year. Even more worrisome is the forecast of inflation, which continues well below the ECB's target of almost 2% in the coming years, which suggests that the bank will still not meet its objective well into the next decade. Commerzbank economist Michael Schubert points out that "in view of the negative interest rates, the excess of liquidity recorded and the nature of the current problems, the impact of other additional measures applied by the ECB could be lower".

The underlying debate, in any case, is deeper. The ECB's chief economist, Peter Praet, already said in February that "the economic climate of the euro area changes fundamentally and not only temporarily" due to trade conflicts and political uncertainty. Praet added that the ECB should react should the situation worsen and announced that the Governing Council would soon discuss new liquidity operations in the very long term. ECB executive committee member Benoît Coeuré has also mentioned the upcoming discussion on new liquidity operations, fearing that commercial banks will reduce their loans disproportionately if the economy continues to deteriorate, because they can scarcely take on more risk because their profits are weak.


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