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ECB expected to launch new economic stimulus

2016-03-10 08:09:44

The European Central Bank is expected to announce further measures to stimulate

the eurozone economy when its governing council meets on Thursday.

Inflation has continued to fall, putting more pressure on ECB president Mario

Draghi to take action.

The annual rate of inflation now stands at minus 0.2% - even further below the

bank's target of just under 2%.

A figure that low underlines the weakness in the economies of the 19 countries

that use the euro.

The ECB is widely expected to cut the deposit rate for funds from commercial

banks even further into negative territory. Such a move is intended to

encourage banks to lend more money and boost economic activity in theory.

The deposit rate for funds from commercial banks stands at minus 0.3%, which

means they must pay to park money with the ECB, but may be cut to minus 0.4% or

even minus 0.5%.

The negative rate is regarded as a drastic and experimental move that reveals

just how far the ECB is from meeting its inflation target.

The ECB could also expand its bond-buying programme, also known as quantitative

easing, which pumps newly printed money into the economy.

It may decide to buy more than the current 60bn of bonds a month. The bank

uses new cash to buy government and some private-sector bonds from banks. That

pushes more euros into the banking system in the hope they will be loaned to

businesses and consumers. In theory, that should eventually raise inflation and

economic activity.

The programme could also be extended past its existing March 2017 end date.

Ben May, an analyst at Oxford Economics, said the ECB could raise the purchases

to as much as 80bn a month.

Mr Draghi may also say that the ECB will not make banks hold more cash as

reserves against possible losses, easing financial pressure on them.

His comments will be scrutinised for signs of dissent on the 25-member council.

Jens Weidmann, the head of Germany's central bank and a governing council

member, has repeatedly warned against more ECB stimulus.

More broadly, the Bank for International Settlements - an international

organisation of central banks - said in a report on Sunday that central bank

measures could be "approaching their limits".

'Negative rate battle'

Traders will also monitor the effect of Mr Draghi's comments on the euro.

Exports benefit if the euro falls against other currencies.

Marco Valli, chief eurozone economist at UniCredit Research, fears that the ECB

may become "trapped in a negative rate battle" with other central banks such as

those in Japan, Sweden and Switzerland that have also cut their rates below

zero and encouraged their currencies to weaken.

If one currency falls, another must rise, cancelling out the effect of any

stimulus measures.

However, Spreadex financial analyst Connor Campbell warned that no matter what

Draighi revealed investors may well be disappointed: "Given the arguable lack

of effect the past and present programmes have had, it is difficult to tell

what the markets would treat as a satisfactory announcement from the central

bank."

Analysis: Kamal Ahmed, economics editor

Negative interest rates sound like they come, fully formed, from the Through

the Looking Glass world of economics.

Central banks in countries or geographies with a growth problem - Japan and the

eurozone, for example - have used them to try and encourage lending and boost

inflation.

Surely it is better for banks to put funds to work in the real world than

deposit them at a central bank - and pay them for the privilege.

Sadly, that does not appear to be the case.

Highly regulated banks deposit excess funds with central banks because it is

secure.

Lending to a wider range of businesses or buying into different asset classes

is riskier and could have an expensive impact on the amount of capital the bank

has to hold.

Negative interest rates have also tended to undermine banks' ability to make

profits.

In a hyper-low interest rate world, banks feel unable to pass on the increased

costs of negative interest rates to customers and are taking the hit

themselves.

Bank share prices have fallen markedly in the last year as negative interest

rates add to the financial services gloom.

And, if central banks are resorting to such unorthodox monetary policies,

doesn't it just show that the global economy is in much more of a mess than

anyone is admitting?