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Draghi seen expanding QE by economists fearing shallow recovery

Monday, September 14, 2015 - 17:50
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Mario Draghi's promise that the European Central Bank is willing to step up its stimulus if needed is resonating with economists, who see the euro-area recovery as too shallow to be sustained.

[FRANKFURT] Mario Draghi's promise that the European Central Bank is willing to step up its stimulus if needed is resonating with economists, who see the euro-area recovery as too shallow to be sustained.

More than two-thirds of respondents in a Bloomberg survey predict the ECB's president will expand or extend the 1.14 trillion-euro (US$1.3 trillion) quantitative-easing program, and almost all of those say he'll do so within nine months. While an increasing number of respondents see the economy improving for now, they're also fretting that the upturn won't last long.

The ECB's Governing Council has already shown concern that a slowdown in global trade will erode exports, a pillar of the regional recovery, before domestic demand is strong enough to compensate. The central bank this month cut its growth and inflation forecasts and Mr Draghi told reporters that QE is flexible in size, duration and composition. In contrast, the Federal Reserve may raise its interest rates as soon as this week.

"QE risks becoming a semi-permanent feature," said Gianluca Sanna, a portfolio manager at Banca Monte dei Paschi di Siena SpA in Milan. "While it's certainly true that the eurozone is indeed going through a phase of decent, maybe even above- potential, output growth, chances are that there is nothing self-sustaining in what we are seeing right now and the eurozone ends up again in a low-growth environment with inflation dangerously close to zero."

In the survey, 68 per cent of the 41 economists polled said the ECB will step up its QE program. Of those who provided a timeline, 65 per cent predict an announcement by December and 87 per cent see a commitment to more stimulus by March.

Nearly four-fifths of the respondents who expect a bigger QE program see the ECB extending its duration beyond the initial end-date of September 2016. About 43 per cent said the monthly purchase amount will be lifted above the current 60 billion euros, and 29 per cent said the central bank will broaden the range of assets it buys.

The Frankfurt-based central bank has other options, though with less control over their scale. The fifth round of its targeted long-term loans to banks - aimed at rekindling lending to companies and households - will take place next week. Economists predict banks will opt to take up 70 billion euros, compared with the 73.8 billion euros they borrowed in June. The loans fall due in September 2018 and are charged at the benchmark interest rate of 0.05 per cent.

Economic growth is returning, if unevenly. Figures published Monday showed industrial production rose 0.6 per cent in July, twice as much as economists predicted, as output jumped in Germany, Spain and Italy, while declining for a second month in France.

The 19-nation economy expanded 0.4 per cent in the second quarter after 0.5 per cent in the first. ECB data show credit standards eased and loan demand climbed in the second quarter. That bodes well for investment, which rose about 1 per cent in the first half of the year.

"The recent data reinforce the image of a continued, gradual recovery," ECB Governing Council member Jens Weidmann told reporters in Luxembourg on Saturday.

"With respect to the direction of European monetary policy, these provide more arguments for a stable-hand policy, even though the uncertainty with regard to the economic outlook is definitely still high."

The share of economists saying the region's short-term outlook will improve rose to 32 per cent, compared with 28 per cent last month. Only 5 per cent said prospects will deteriorate.

Yet the concern is the fragility of the revival, as China's slowdown drags on emerging nations and potentially on global growth. A rout in financial markets started last month when the country devalued its currency to shore up its economy. Oil prices dropped to a six-year low, threatening to tip the euro- area inflation rate negative again.

"The domestic situation of many eurozone economies has improved, particularly in Spain and Ireland, but headwinds from abroad, namely China, Brazil and some other emerging markets, have increased," said Fabian Fritzsche of Collineo Asset Management GmbH in Dortmund, Germany. "However, I think the positive effect of the lower crude-oil price will exceed the negative effect of lower export growth to the emerging markets at least in the short term."

The ECB now forecasts the euro area will expand 1.4 per cent in 2015, 1.7 per cent in 2016 and 1.8 per cent in 2017. Officials cut their 2017 inflation forecast to 1.7 per cent, a signal that more stimulus may be needed to ensure they reach their goal of medium-term price growth just below 2 per cent.

"All options are open to the ECB as regards stepping up its QE program," said Alan McQuaid, chief economist at Merrion Capital Group Ltd in Dublin. "Initially I see them broadening the range of assets purchased, then upping the monthly amount and then finally extending the program beyond September next year."

BLOOMBERG