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European Bank President Facing The Unknown

Saturday, 31 May 2014 06:34 AM

Mario Draghi is preparing to lead the European Central Bank into the unknown.

From negative interest rates to conditional liquidity for banks, the bank president and his fellow policy makers have signaled all options are up for discussion when they meet on June 5. Of the 50 economists surveyed by Bloomberg News, 44 expect the bank to become the first major financial institution to take interest rates into negative territory.

“We are ready to act,” bank Vice President Vitor Constancio said Friday. “We are not complacent about the risks from a protracted period of low inflation.”

The bank is trying to head off the threat of deflation as the economy struggles to cope with the aftermath of a debt crisis that threatened at one point to blow up the euro, the common currency used by 18 of the 28 countries in the European Union.

Possible options include suspending the absorption of liquidity created by crisis-era bond purchases or re-purposing its offerings of unlimited cash to encourage bank lending. That would help address a credit squeeze still holding back a recovery in southern Europe.

“For monetary policy to produce its full effects, there must be no binding constraints on credit supply through the banking system,” Draghi said in a speech in Portugal on May 26. If banks don’t have the cash on hand to make loans, “monetary policy can play a bridging role,” he said.

The interest rate on new liquidity offerings could be tied to a bank's willingness to lend to certain industries, the Financial Times reported Friday, citing sources  familiar with the situation.

“If a set of measures is taken ... they will all go into the same direction,” Constancio said in an interview Wednesday after the institution published its Financial Stability Review. “The greatest concern we have as a central bank is indeed the possibility, the risk, that a prolonged period of low growth and inflation will create all kinds of risks.”

The European Central Bank is likely to cut its deposit rate to minus 0.1 percent from zero at present, according to 32 of the economists in Bloomberg’s survey. Twelve more predicted a reduction to minus 0.15 percent.

Economic data in the coming days is also likely to reinforce the view that action is needed, with economists predicting they will show a grim mixture of too-low inflation and unemployment near a record.

A report on Tuesday will probably show that inflation slowed to 0.6 percent in May from 0.7 percent in April, according to the Bloomberg survey. That would leave it under 1 percent for an eighth month, well short of the bank's aim of keeping it just below 2 percent.

Unemployment data, due the same day, will probably show the jobless rate stayed at 11.8 percent in April, close to the record 12 percent reached last year, another survey showed.

“If you look at the broader array of economic data that is currently out there, then pretty much all of it points to the need for further stimulus,” said James Ashley, chief European economist at RBC Capital Markets in London. “We’re looking at conventional and unconventional steps.”

Draghi will also unveil new growth and inflation projections this week, which may determine how far the central bank is prepared to go.

The central bank forecast in March that inflation would average 1 percent this year and 1.3 percent in 2015. Goldman Sachs Group Inc. says it will probably cut its 2014 projection to 0.8 percent.

The growth forecast for this year may also be lowered after the economy’s sluggish performance in the first quarter. Bank of Italy Governor Ignazio Visco last week pointed to the importance of the new forecasts.

Inflation and unemployment statistics are not all that the bank's Governing Council will have to digest this week. An update to first-quarter euro-area gross domestic product on Wednesday will be published, showing how much or little consumers, governments and trade contributed to growth. In addition, Markit Economics will publish its final readings for manufacturing and services.

“They’ve telegraphed action,” said Jacques Cailloux, chief European economist at Nomura International Plc in London. “The speculation is what will they do on top of the rate cut that’s looking like a done deal.”

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Mario Draghi is preparing to lead the European Central Bank into the unknown. From negative interest rates to conditional liquidity for banks, the bank president and his fellow policy makers have signaled all options are up for discussion when they meet on June 5.
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Saturday, 31 May 2014 06:34 AM
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