By Francesco Canepa and John O’Donnell
Fading growth and inflation prospects will force the European Central Bank to review its policy stance in March, President Mario Draghi said on Thursday, a strong signal that more easing could be coming within months.
Global market turmoil, plunging oil prices and weaker growth across emerging markets are quickly increasing economic headwinds for Europe so the ECB will need to be ready to use any possible instrument as inflation risks turning negative and growth slows, Draghi said.
The unexpectedly strong comments weakened the euro by nearly 1 per cent and markets quickly priced in a rate cut for March, three months ahead of previous forecasts, concluding that Draghi all but promised action, much like in October when he set up a December rate cut and an extension of the ECB‘s asset-buying programme.
Bolstering market hopes of more support, Draghi added that the ECB was unanimous in its communication stance on Thursday, a contrast to December when several notable hawks voted against policy easing.
“Downside risks have increased again amid heightened uncertainty about emerging market economies’ growth prospects, volatility in financial and commodity markets, and geopolitical risks,” Draghi told a news conference. “We are not surrendering in front of these global factors.”
Financial and commodity markets have been shaken by a further collapse in oil prices, signs that China’s economy is losing momentum and, more recently, worries about the health of banks in Italy and other weaker eurozone economies.
Dismissing concern that the ECB‘s policy arsenal is all but empty, Draghi said: “We have the power and willingness and determination to act. There are no limits to how far we are willing to deploy our (monetary) instruments.”
RATE CUT, BIGGER QE?
“Pulling forward the deposit rate cut to March is easy,” JPMorgan economist Greg Fuzesi said. “But a six-month QE extension is quite far in the future, while today’s meeting suggests greater urgency.”
He said options include a rate cut in excess of 10 basis points, an increase in monthly asset buys from 60 billion euros to 70 billion euros, opening the door to a tiered deposit rate and additional long term refinancing operations.
In December, the ECB Governing Council cut the deposit rate to -0.3 per cent from -0.2 per cent, increasing the charge on banks for parking money at the ECB, and expanded its 1.5 trillion euros quantitative easing programme.
But inflation prospects have turned for the worse, raising a credibility issue for a bank that has undershot inflation for three straight years.
The ECB‘s December projections, which already indicated an inflation miss for years to come, were based on crude oil prices averaging $52.2 this year. But Brent crude is trading around $27 per barrel and even 2022 oil futures are below $50, indicating little confidence in a quick rebound.
“As inflation will be stuck at lower levels for a longer time, while inflation expectations will probably be slow to react to the new measures, another easing package is likely to be needed in the June meeting,” Nordea said.
“(Draghi’s) comments leave markets room to once again price in more easing, i.e. lower bond yields, narrower spreads and a weaker euro,” it added.
Draghi also rejected arguments to simply look through the oil price shock, arguing low energy prices are likely to last, a risk that they would drag down the price of other goods and service, creating a downward spiral that is difficult to break.
But he said China’s leadership appears to have got a handle on the economy’s troubles and that Europe’s bank sector, a source of stain in the past, appears to be resilient.
Still, China’s difficulties are far from resolved and economists expect growth to slow further, likely prompting more currency devaluation and central bank easing.
The weakening yuan would export China’s deflationary risk and reduce the effectiveness of any rate cuts by limiting the ECB‘s ability to weaken the euro.
Weakness in China could also persuade the US Federal Reserve to slow its rate increases, also putting the euro under firming pressure and dampening the impact of any ECB easing.
Hoping to sooth European bank investors, caught in a sell-off in recent weeks, Draghi said any action to reduce banks’ high stock of non-performing loans would take years, dismissing fears of imminent action.
Shares in southern European banks, particularly in Italy where the level of bad debt is particularly high, had fallen sharply on worries that the ECB could force them write down the value of bad loans.