ECB expected to launch new economic stimulus


Source: BBC

The European Central Bank is expected to announce further measures to stimulate the eurozone economy when its governing council meets on Thursday.

Inflation has continued to fall, putting more pressure on ECB president Mario Draghi to take action.

The annual rate of inflation now stands at minus 0.2% – even further below the bank’s target of just under 2%.

A figure that low underlines the weakness in the economies of the 19 countries that use the euro.

The ECB is widely expected to cut the deposit rate for funds from commercial banks even further into negative territory. Such a move is intended to encourage banks to lend more money and boost economic activity in theory.

The deposit rate for funds from commercial banks stands at minus 0.3%, which means they must pay to park money with the ECB, but may be cut to minus 0.4% or even minus 0.5%.

The negative rate is regarded as a drastic and experimental move that reveals just how far the ECB is from meeting its inflation target.

The ECB could also expand its bond-buying programme, also known as quantitative easing, which pumps newly printed money into the economy.

Mario DraghiImage copyrightGetty Images
Image captionECB president Mario Draghi

It may decide to buy more than the current €60bn of bonds a month. The bank uses new cash to buy 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 programme could also be extended past its existing March 2017 end date.

Ben May, an analyst at Oxford Economics, said the ECB could raise the purchases to as much as €80bn a month.

Mr Draghi may also say that the ECB will not make banks hold more cash as reserves against possible losses, easing financial pressure on them.

His comments will be scrutinised for signs of dissent on the 25-member council.

Jens Weidmann, the head of Germany’s central bank and a governing council member, has repeatedly warned against more ECB stimulus.

More broadly, the Bank for International Settlements – an international organisation of central banks – said in a report on Sunday that central bank measures could be “approaching their limits”.

‘Negative rate battle’

Traders will also monitor the effect of Mr Draghi’s comments on the euro. Exports benefit if the euro falls against other currencies.

Marco Valli, chief eurozone economist at UniCredit Research, fears that the ECB may become “trapped in a negative rate battle” with other central banks such as those in Japan, Sweden and Switzerland that have also cut their rates below zero and encouraged their currencies to weaken.

If one currency falls, another must rise, cancelling out the effect of any stimulus measures.

However, Spreadex financial analyst Connor Campbell warned that no matter what Draighi revealed investors may well be disappointed: “Given the arguable lack of effect the past and present programmes have had, it is difficult to tell what the markets would treat as a satisfactory announcement from the central bank.”

Analysis: Kamal Ahmed, economics editor

Negative interest rates sound like they come, fully formed, from the Through the Looking Glass world of economics.

Central banks in countries or geographies with a growth problem – Japan and the eurozone, for example – have used them to try and encourage lending and boost inflation.

Surely it is better for banks to put funds to work in the real world than deposit them at a central bank – and pay them for the privilege.

Sadly, that does not appear to be the case.

Highly regulated banks deposit excess funds with central banks because it is secure.

Lending to a wider range of businesses or buying into different asset classes is riskier and could have an expensive impact on the amount of capital the bank has to hold.

Negative interest rates have also tended to undermine banks’ ability to make profits.

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