ECB to announce measures to prop up ailing economy

European Central Bank (ECB) President Mario Draghi. (Reuters Photo)

 

FRANKFURT, Sept 12 (Reuters) -

The European Central Bank is set to unveil fresh stimulus measures on Thursday to prop up the ailing euro zone economy, but its exact moves are far from certain and a decision that underwhelms markets risks pushing up borrowing costs.

With other major central banks easing monetary policy, Germany at risk of falling into recession and inflation expectations sliding, ECB President Mario Draghi has all but promised more support, putting all of the bank's remaining tools in play.

However, Draghi, who hands over the leadership of the central bank to Christine Lagarde at the end of October, will face push back from more conservative members of his Governing Council.

Some policymakers have voiced concerted, public opposition to more radical stimulus measures, particularly the restarting of bond purchases, known as quantitative easing.

Also, Draghi's dovish talk has raised investors' expectations so high that it will be difficult to fully deliver on them, leaving the ECB at risk of disappointing. This could see market interest rates increase, rather than fall.

While the ECB has a wide range of policy instruments at its disposal, each comes with complications, from questionable efficacy and big side effects.

The euro zone's biggest troubles -- a global trade war, Brexit and China's slowdown -- are also outside the central bank's control, suggesting that any stimulus would have a limited impact.

Still, the ECB is expected to lower some of its growth and inflation projections, highlighting the broader risk to the economy.

Sources told Reuters that the forecasts will predict the growth of not much more than 1 per cent both this year and next while underlying and headline inflation will rise only modestly.

The central bank aims for euro zone inflation of just below 2%, a target it has failed to hit since 2013.

 "REINFORCED" POLICY GUIDANCE

A cut in the ECB's minus 0.4% deposit rate - already a record low - appears to be the least contentious move and policymakers will debate a 10 or 20 basis point reduction.

Although this would lower short term corporate borrowing costs, it would immediately hit bank profits as negative rates essentially amount to a penalty charge on their more than 1 trillion euros worth of excess reserves.

So the ECB is likely to exempt banks from part of this charge by introducing a multi-tier deposit rate.

While this option would give an immediate boost to banks, critics argue it would only be small and would disproportionately benefits banks in France and Germany.

The ECB is also expected to push out the timing of any rate hike even further, providing "reinforced" guidance on rates that will tie any move to certain inflation conditions, lowering the emphasis on calendar dates.

The ECB announces its rate decision at 1145 GMT, followed by Draghi's news conference at 1230 GMT.

 

QE CLASH?

The most contentious part of the package will be whether to restart bond purchases.

Although this is the ECB's most powerful weapon, over half a dozen policymakers, including the central bank chiefs of Germany, France, the Netherlands and Austria have expressed scepticism about the need for it.

They argue the bloc is merely experiencing a slowdown, not a recession, and such a tool should be reserved for real crises, especially since the ECB has already used up much of its firepower in past rounds of stimulus.

Indeed, rates are a record low and the ECB's balance sheet is more than a third bigger than the U.S. Federal Reserve's, indicating limited room for more action.

But with the Fed cutting rates last month and sending some dovish signals about future policy, the ECB can hardly avoid keeping pace to stop the euro from appreciating and further dampening inflation.

"While we don’t see much room for the ECB to disappoint on rate cuts, forward guidance and tiering, we think the Governing Council may be less dovish than what is priced in by delivering a less generous asset purchase programme," Nomura said.

Draghi is still likely to have the votes if he wants to go ahead with bond purchases, but opposition from the bloc's biggest economies could be damaging to the bank's authority.

Possible compromises include approving a relatively small bond purchase scheme without changing previously established purchase limits, to avoid stirring up a legally contentious issue.

Another issue is that with Draghi leaving on Oct. 31, some policymakers appear less keen to make a long-term commitment that would tie the hands of the bank's next president.

"A compromise solution could be to announce QE but to leave the details until later this would buy more time for the ECB Governing Council to reach a consensus and allow incoming President Christine Lagarde to "own" the programme," BNP Paribas economist Luigi Speranza said.

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