European Central Bank eyes future stimulus as deflation rears head

The European Central Bank is expected Thursday to hint at new stimulus measures, armed with a fresh set of economic forecasts amid rising Brexit tensions and fears of a coronavirus resurgence.

The ECB will publish its latest assessments on the eurozone's growth prospects through to 2022, which will be closely scrutinised for signs of whether the worst of the pandemic's devastating economic impact is over.

Inflation trends will also be key as fears of deflation are fuelled by a climbing euro, faltering oil prices and consumers putting off purchases in the grim economic climate.

Second-quarter data published on Tuesday confirmed the largest-ever quarterly decline in eurozone GDP and while the recovery in the third quarter may be steep, many economists predict the rapid rebound phase has already come to an end.

News this week that Britain may renege on its withdrawal agreement with the European Union, raising the possibility of a no-deal Brexit that could massively disrupt trade, further complicates the picture.

The Frankfurt-based institution is in the process of pumping 1.35 trillion euros ($1.59 trillion) into the eurozone economy through its pandemic emergency bond-buying programme, known as PEPP.

The aim of the huge stimulus scheme is to keep borrowing costs low and to encourage spending and investment in a bid to drive up growth and inflation.

But with no end to the health crisis in sight, investments are lacklustre while households are hesitant to take on loans.

Across the Atlantic, a major policy shift by the US Federal Reserve has also thrown a spanner in the works.

In a stunning change, the Fed last month said it would allow inflation to accelerate to let the economy generate more jobs.

The announcement triggered a significant weakening of the US dollar against the euro, which could make eurozone exports more expensive and less competitive.

BNP Paribas economist William De Vijlder said the ECB was faced with "three headaches".

"Inflation is too low and declining, the strong euro reinforces this development and there is concern that the change in the longer-term goal of the Fed... will complicate matters," he said.

The euro recently touched $1.20 for the first time in two years, from $1.06 in March, only paring some of the gains when the ECB's chief economist Philip Lane said the exchange rate "does matter" for monetary policy.

ECB chief Christine Lagarde's press conference at 1230 GMT will be scrutinised for hints on how the eurozone could hold down the euro.

Analysts are not expecting any policy tweaks to be announced, with ECB governors likely to keep interest rates at historic lows and hold off for now on expanding the PEPP envelope.

What will count most on Thursday "is the question of whether the stronger euro has already opened the door for more monetary stimulus in the coming months," said ING chief economist Carsten Brzeski.

"Were it not for the strong euro, the September European Central Bank meeting on Thursday would probably have been a non-event," he added.

A new set of inflation forecasts could well strengthen the case for additional monetary easing.

The bank will likely add stimulus later in the year, according to Berenberg analyst Florian Hense, should the ECB predict that inflation will be well below two per cent in its first forecast for 2023 at its December meeting.

The ECB defines price stability as inflation rates of "below, but close to" 2.0 per cent.

Alarm bells sounded last week when data showed eurozone inflation turned negative in August -- coming in at -0.2 per cent -- because of plummeting demand in face of the pandemic.

While deflation, or falling prices, benefits consumers in the short run, if they begin delaying purchases in the hope of goods and services becoming even cheaper, it harms companies' earnings and can lead to job cuts, making consumers anxious and likely to hold back spending further.