European Central Bank head Mario Draghi has all but promised more monetary stimulus for the 19-country eurozone economy at Thursday’s meeting of the bank’s governing council.
Now the question is, exactly how much will he deliver — and how much effect will it have?
Expectations at a minimum are that the ECB’s governing council will cut the deposit rate for funds from commercial banks even farther below zero, a step aimed at pushing banks to lend.
And the ECB, the top monetary authority for the countries that share the euro currency, could also increase its bond-buying program, which pumps newly printed money into the economy.
The reason for more stimulus would be to boost dangerously low inflation. Since the council’s last meeting, inflation has sunk even farther below the bank’s target of just under 2 percent, to an annual rate of minus 0.2 percent. A reading that low is a sign of economic weakness and some experts fear it could become ingrained, weighing on growth in the longer-term.
Much depends on whether the ECB’s efforts work. If Europe’s modest recovery falters, it would add to the drag on the global economy from slowing growth in China.
Yet doubts are growing among economists about whether central banks around the world are reaching the limits of what they can do.
Here are five themes to watch from the meeting and Draghi’s news conference.
Analysts think the ECB will ramp up its bond purchases from 60 billion euros per month, or extend it, or both. Under the program, the ECB creates money and uses those new euros to purchase government and some private-sector bonds from banks. That pushes more euros into the banking system in the hope they will be loaned to businesses and consumers. In theory, that should eventually raise inflation and economic activity.
The bank could also extend the program, slated to run at least through March 2017.
Ben May, analyst at Oxford Economics, thinks the ECB could raise the purchases to as much as 80 billion euros per month.
The bank could also cut its deposit rate on funds left with it by commercial banks, from the current minus 0.30 percent to minus 0.40 or even minus 0.50 percent.
The negative rate is a drastic and experimental step that underlines how far the ECB is from achieving its inflation target. It is aimed at penalizing banks for hoarding cash at the central bank’s ultra-safe deposit facility and to push them to lend it instead.
But such strong medicine can have serious side effects. Negative rates could hurt bank profits because it amounts to a tax on their spare cash, and squeezes their profit margins. Bank shares have seen violent swings due to fears about how negative rates will affect them.
And, more to the point, weak banks don’t lend.
The ECB could try to limit the impact on bank’s finances by introducing a tiered rate: a more negative rate above a certain amount of excess funds left on deposit.
And Draghi may also underline that the ECB will not be asking banks to increase their capital buffers against losses, easing financial pressure on them.
The key pretext for any ECB action will be new inflation forecasts. That’s because the ECB’s main mission in life is price stability, a mandate enshrined in the basic European Union treaty.
At the meeting, the bank’s policymakers will get the first forecasts for 2018.
If the estimate remains far below the goal of just under two percent, the argument for more stimulus would be crystal clear.
Draghi’s remarks will be scrutinized for signs of dissent on the 25-member council. Jens Weidmann, the head of the German national central bank and a governing council member, has been a leading voice warning that excessive central bank stimulus risks taking the pressure off national governments to do their part to make the eurozone economy work better. Governments are asked, among other things, to reduce bureaucracy and regulation to make it easier to start and grow businesses.
Weidmann is one of four members who won’t have a vote Thursday due to the ECB’s system of rotating voting rights among member countries. But he’s not the only stimulus skeptic on the board. Resistance could mean a smaller package result from the meeting.
More broadly, the Bank for International Settlements — an international organization of central banks — warned in a report Sunday that central bank measures “were seen to be approaching their limits.”
Markets will watch what Draghi says about the euro’s exchange rate. Although the bank insists it does not use monetary policy to influence the exchange rate, a weaker euro is one of the chief benefits of the move to negative deposit rates as it helps exports.
The euro’s average exchange rate against key trading partners’ currencies has fallen in recent days but remains above its level at the bank’s Dec. 3 meeting.
Marco Valli, chief eurozone economist at UniCredit Research, argues that larger, further deposit rate cuts may have less and less effect on the euro. That’s a reason to cut by smaller 0.10 percentage points, instead of 0.20 percentage points.
He says the ECB may see a risk of eventually being “trapped in a negative rate battle” with other central banks — such as those in Japan, Sweden, and Switzerland — that are also cutting their rates below zero and weakening their currencies.
Since one currency’s drop is another currency’s rise, it would be hard for anyone to win and stimulus measures aimed at a lower currency would cancel each other out.