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ECB seeks balance to keep low-inflation recovery on rails

Financial markets are on alert for the slightest change in stance from the European Central Bank and its president Mario Draghi
AFP

Frankfurt am Main (AFP) – European Central Bank president Mario Draghi will paper over discord among colleagues at a press conference Thursday, analysts predict, with policymakers divided on their response to heftier economic growth unaccompanied by higher inflation.

Top central bankers know the end is in sight for massive support to the 19-nation eurozone.

But the ECB’s governing council meeting in Frankfurt will bring another round in the battle over how quickly to wind down mass bond-buying and ultimately raise interest rates.

Meanwhile, financial markets are on alert for the slightest change in the bank’s stance, after minutes from December’s meeting showed governors plan to “revisit” policy early this year.

The ECB has bought almost 2.3 trillion euros ($2.8 trillion) of government and corporate bonds, offered cheap loans to banks and set interest rates at historic lows, aiming to stoke eurozone growth and boost inflation towards its target of just below 2.0 percent.

Like other central banks worldwide it has puzzled as higher economic growth — estimated at 2.4 percent in 2017 — and reduced unemployment have not brought faster price increases.

Euro area inflation fell to just 1.4 percent in December, well short of the ECB target, and is seen climbing only to 1.7 percent by 2020 in forecasts.

“While the strength of the economy suggests that extraordinary policy support is becoming unnecessary, the inflation outlook does not seem to warrant policy tightening,” analyst Jennifer McKeown of Capital Economics summed up.

– No choice but to move –

Some ECB chiefs argued at December’s meeting that “a policy stance that remained in crisis configuration” was no longer needed, according to minutes of the discussion.

Policymakers decided in October to cut bond-buying by half to 30 billion euros per month and set a time limit of September.

“We can be hopeful that the October extension was the last one,” ECB executive board member Benoit Coeure told German business daily Handelsblatt in November.

Council members in favour of a prolonged, gentle exit from bond-buying are fighting a rearguard action against more aggressive “hawks”, as the bank approaches technical limits to bond-buying that could open it to legal challenge.

Bonds from less-indebted countries like Germany or the Baltic states are becoming scarcer.

That forces the ECB to buy more debt from countries such as France, Spain and Italy, departing from its commitment to buy in proportion to nations’ share of its capital, a study published Monday by Germany’s ZEW institute found.

Such constraints mean “the ECB is resigning itself to the inevitable” as it prepares to wind down bond-buying, Commerzbank economist Michael Schubert noted.

“It is compelled to focus on other monetary policy instruments” like interest rates in setting future policy, he added.

The ECB insists that rates are not due an increase until “well after” the end of bond purchases, a flexible deadline that may not come until late in 2019.

– Inching retreat –

For now, some analysts suggest Draghi could make his direction of travel clear by dropping an oft-repeated commitment to increase bond-buying “in terms of size or duration” if economic conditions worsen.

But hinting too strongly at a definitive exit could jolt foreign exchange markets, sending the euro higher against other global currencies.

That would make imports cheaper and sap inflation yet further.

Over the coming months, the ECB will be hoping for signs that faster price growth may be on the way, such as eurozone workers negotiating hard for generous wage increases.

German metalworkers could set the tone, as they press twin demands for a 6.0 percent salary boost and the right to go part-time for up to two years.

Elsewhere unemployment remains high, limiting upward pressure on pay.

“Wages are unlikely to pick up on a broad front” for now, with low inflation on the horizon in the short term, Commerzbank’s Schubert predicted.

“But the ECB is confident that the stronger economy will also lead to a lasting rise in inflation in the foreseeable future” that will dispel its policy woes, he added.

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