ADVERTISEMENT

ECB Tested by Market Calls for Rate Cut That Will Erode Arsenal

ECB Tested by Market Calls for Rate Cut That Will Erode Arsenal

(Bloomberg) --

The coronavirus outbreak is testing the European Central Bank’s reluctance to cut interest rates deeper into negative territory, in President Christine Lagarde’s first confrontation with financial markets.

Little more than a week before the next policy meeting, investors are speculating that the ECB will probably lower its deposit rate to a record-low minus 0.6% from the current minus 0.5%. That’s despite the central bank so far holding off from issuing a statement -- unlike the U.S. Federal Reserve, Bank of Japan and Bank of England -- pledging to act as needed to stabilize tumbling financial markets.

Unless investor expectations are curtailed by the March 12 decision, Lagarde and her colleagues will be debating the merits of further eroding a near-empty arsenal to contain a threat many say is beyond the ability of monetary policy. Inaction, though, risks a market upheaval that could force the bank to cut rates deeper at a later stage.

ECB Tested by Market Calls for Rate Cut That Will Erode Arsenal

The signals so far have been that officials don’t yet see the need for immediate central bank action. ECB Vice Chairman Luis De Guindos said Monday that while policy makers will remain vigilant, governments can offer a more fine-tuned response to the supply disruptions and demand shock that coronavirus brings.

“Fiscal policy is the correct answer,” he said in London. “We should not get confused. When you have a problem, you can’t always look at central banks.”

Limited Space

The ECB’s reticence to take center stage reflects the limited space left after more than half a decade of negative rates and 2.6 trillion euros ($2.9 trillion) of bond purchases that have failed to bring inflation to the central bank’s target. Banks are complaining that their profit margins are being dangerously squeezed, and residents are fed up with surging house prices and depressed returns on their savings.

Lagarde and her peers have repeatedly warned that their ultra-loose policies have side. Yet her calls for higher government spending have been largely met with resistance.

The president, a former French finance minister and head of the International Monetary Fund before joining the ECB in November, has also shown a wariness of focusing too much on investors. She told European lawmakers last month that “markets interpret, misinterpret or over-interpret our actions” and “we have to remain vigilant that we do not focus too narrowly on communicating to markets and create our own echo chamber.”

That may not stop the ECB from acting, either imminently or after other central banks do so, especially if it’s forced to cut its forecasts at this month’s meeting. The OECD slashed its global outlook on Monday and warned that the world economy faces its “greatest danger” since the financial crisis more than a decade ago.

“We think the ECB -- and the Bank of Canada -- will get bounced into joining a global shift, and the People’s Bank of China will probably join too,” Krishna Guha, head of central bank strategy at Evercore ISI, said in a note. “But we see the ECB as the main drag on the feasibility, timeline and aggression of any joint response.”

While many economists say the threat posed by the virus to the economy cannot be fixed through rate cuts, money markets are pricing a greater-than 90% chance that the ECB will lower its deposit rate by 10 basis points next week, and a total of 20 basis points by the end of the year.

ECB Tested by Market Calls for Rate Cut That Will Erode Arsenal

Guha also expects 20 basis points this year, as well as greater purchases of corporate debt and more-generous terms for its bank-lending program.

One of the triggers might be euro-area inflation data on Tuesday, which is expected to show consumer-price growth at 1.2%, drifting further away from the goal of just under 2%.

Lagarde may join a Group of Seven phone call on Tuesday, but has no scheduled appearances before next week’s meeting.

A conference planned for Tuesday at which Guindos and Executive Board member Isabel Schnabel were due to speak has been postponed after multiple cancellations by participants. The ECB starts a weeklong quiet period on Thursday, during which officials are supposed to avoid commenting at all on monetary policy.

For some, it’s a slightly unnerving sign that the ECB’s leadership is still settling in. For the first time in its history, neither the president nor the vice president -- a former Spanish finance minister -- have central-banking backgrounds. Half the Executive Board has been in the job for only a few months.

“I’m a little worried about the ECB being this quiet,” Erik Nielsen, chief economist at UniCredit Bank, said in a Bloomberg Television interview. “I wonder whether this could be that we don’t have super-seasoned central bankers at the top of the ECB right now.”

--With assistance from Brian Swint, Piotr Skolimowski, James Hirai and Zoe Schneeweiss.

To contact the reporter on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Alaa Shahine, Craig Stirling

©2020 Bloomberg L.P.