ECB Is Watched as Central Banks Shift Gears: Decision Day Guide
This verbal policy tool is being keenly watched for any change.
(Bloomberg) -- The European Central Bank will decide on Thursday whether the euro zone needs more stimulus as its global peers move to shore up a recession-threatened global economy.
Officials are in Vilnius, leaving Frankfurt for an out-of-town policy meeting, to review updated forecasts amid plunging inflation expectations and escalating international trade tensions. Investors and economists are increasingly calling for action or for a signal that President Mario Draghi will deliver a last burst of monetary support before his term ends in October.
The discussion takes place against a shifting mood elsewhere. Australia cut interest rates on Tuesday for the first time in three years, the U.S. Federal Reserve has signaled an openness to easing if necessary, and bets are mounting that the Bank of Japan will add stimulus. India reduced its key rate on Thursday and changed its stance to accommodative. Investors now see the ECB lowering rates next year.
Thursday’s decision will be announced at 1:45 p.m. Frankfurt time, and Draghi will speak to reporters 45 minutes later. Here’s what to watch out for:
Interest-Rate Guidance
This verbal policy tool is being keenly watched for any change. The ECB currently says it expects interest rates to stay at record lows at least through the end of this year. That’s more out of line than ever with market views -- economists see no chance of a near-term rate increase and investors are betting the next move will be a cut in 2020.
Evercore ISI’s Krishna Guha notes a “wild-card possibility” that the ECB will change from time-dependent guidance to inflation-dependent guidance -- saying what price-growth criteria would warrant a rate rise. Market-based inflation expectations are currently at their lowest since 2016.
TLTRO-III
The ECB’s next round of long-term loans to bank is technical but important, and analysts expect to hear how generous the funding terms will be. Get it right, and it’ll support lending to companies and households. The number to watch is the so-called incentive, an interest rate that could be as low as minus 0.4%.
What Our Economists Say...
“With external risks intensifying, we think the ECB will want to keep its lending facility as a robust backstop and keep the option to set its rates as low as the deposit rate.”
- Maeva Cousin and David Powell. See their ECB PREVIEW
Interest Rates
Unlike the U.S. Federal Reserve and the Bank of England, ECB interest rates are still stuck at record lows -- minus 0.4% in the case of the benchmark deposit rate. Another cut would draw howls from German savers, and from banks that are struggling to pass the charge onto their customers.
Yet Draghi has opened the door to another reduction by promising to review whether banks need some relief -- for example by exempting some deposits from the charge, as the Swiss National Bank does. His colleagues have been unenthusiastic, but if he presses on then that could be a signal that rate cuts are being seriously discussed.
“They need to perhaps reopen the door to more easing,” Frederik Ducrozet, global strategist at Banque Pictet & Cie. told Bloomberg TV. “Eventually if inflation expectations are drifting lower we know that the policy response should be QE.”
Quantitative Easing
Ducrozet isn’t alone -- ABN Amro made a bold call this week saying the ECB will restart QE from January. The central bank bought 2.6 trillion euros ($2.9 trillion) of sovereign debt, covered bonds, corporate bonds and asset-backed securities from 2015 until the end of 2018. Resuming the program would probably require the institution to ease some of its self-imposed limits on how much debt it could buy.
“The ECB clearly has a very poor toolbox at the moment,” Geraldine Sundstrom, the head of asset allocation at Pimco, said in a Bloomberg TV interview. “The ECB is a lot more handcuffed than other central banks like the Fed.”
Keep Calm
The news isn’t all bad -- regional unemployment is at the lowest since 2008, supporting nascent wage pressures, and economic confidence might be starting to turn up. With its arsenal depleted, policy makers could opt to save some firepower for the future. The risk of doing nothing is that investors may flee to safe havens such as German bonds, pushing up yields elsewhere and damaging the recovery.
Draghi’s Legacy
The 25-member Governing Council takes decisions by consensus, or occasionally by vote, but Draghi will be aware that his legacy is at stake. His actions now affect the odds that the euro-zone economy is on track toward price stability when he leaves at the end of October.
The decision will also partly tie the hands of his successor. European Union politicians are only just getting down to a complex set of negotiations over top posts that include the presidencies of the ECB, European Commission and council of leaders. There’s a good chance the eventual winner already sits on the Governing Council -- and so will be party to Thursday’s policy session.
--With assistance from John Ainger and Carolynn Look.
To contact the reporter on this story: Piotr Skolimowski in Frankfurt at pskolimowski@bloomberg.net
To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Paul Gordon, Zoe Schneeweiss
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