ECB heads to island gathering as more QE seen a matter of time

[FRANTFURT] A rocky outcrop exposed to the elements appears to be just the right setting for the European Central Bank to discuss whether the euro-area economy needs more help.

ECB President Mario Draghi will convene his Governing Council on the Mediterranean island of Malta this week to set monetary policy for a 19-nation region that is seeing its recovery buffeted by slowing international trade and global market volatility.

Officials are likely to say by the end of the year that they have no choice but to add stimulus, and may even reach that conclusion as soon as Thursday, according to economists in a Bloomberg survey.

While ECB speakers have publicly trailed the line that it's too early to tell whether an emerging-market downturn and commodity-price slump will derail the euro area's already- sluggish revival, the pressures are mounting. Governing Council member Ewald Nowotny sent the euro tumbling last week when he said even core inflation, which strips out the effect of lower energy prices, is "clearly" below target.

"It is only a matter of time before more action is taken," said Alan McQuaid, chief economist at Merrion Capital Group in Dublin.

"Inflationary pressures remain very muted, and unless there is a dramatic rise in the price of oil, which looks unlikely in the short term, then the ECB is not going to meet its inflation target any time soon."

The 25-member Governing Council will gather in Malta - the euro area's smallest economy - starting on Wednesday, in one of two meetings it holds each year outside its headquarters in Frankfurt.

Its interest-rate decision will be announced at 1.45pm the next day and Mr Draghi will hold a press conference in Valletta 45 minutes later. Stormy weather is forecast on both days, according to weather.com.

While the economists surveyed say the ECB will probably hold off from announcing more quantitative easing immediately, 81 per cent of the 53 respondents predict it will do so eventually, compared with 68 per cent in a similar poll last month. Of those who expect an expansion in the stimulus plan, 56 percent said it'll happen this year and 30 percent said the decision will be taken next quarter.

Of the economists that see QE being altered, 81 per cent said the ECB will extend the duration of the programme past the initial end-date of September 2016, and 42 per cent said officials will increase the size of monthly purchases from 60 billion euros (S$94.3 billion).

Just over a quarter said the central bank will expand the range of assets it buys beyond the current list of public-sector debt, covered bonds and asset- backed securities.

A further cut to the deposit rate was forecast by 4 per cent of respondents. That's an option policy makers haven't publicly addressed, and Mr Draghi said more than a year ago that the rate reached the lower bound when it was reduced to minus 0.2 per cent. Even so, the market is pricing in at least a 50 per cent chance of a 0.1 percentage-point cut, according to UBS Group AG.

"As a last resort, we believe that a cut in the rate of the deposit facility is a possibility," said Philippe Gudin, an economist at Barclays Plc in Paris. "However, we think this option is probably unlikely to be triggered before year-end as it is still quite controversial."

RAISING PRESSURE

The ECB has bought almost half a trillion euros of debt under QE, as well as keeping official rates near zero and providing 400 billion euros in cheap long-term loans to banks.

Yet inflation was minus 0.1 per cent in September, the first negative reading since QE started in March, compared with a medium-term goal of just under 2 per cent. The core rate, which excludes food and energy, was 0.9 per cent.

That's raising the pressure on Mr Draghi to act on his longstanding pledge that the central bank will add stimulus if needed.

So far, policy makers have been consistent in saying it's too early to decide what to do.

Executive Board member Sabine Lautenschlaeger said in an interview in Lima this month that talking about concrete measures now would be "really premature" and reiterated the ECB's stance that only governments can turn the cyclical recovery into a structural one.

"One has to say that we're clearly missing our target," Mr Nowotny said in Warsaw on Oct 15. "The ECB is using the monetary-policy instruments available, but in my view it is quite obvious that in the current economic situation additional sets of instruments are necessary."

WORSENING OUTLOOK

The ECB predicted last month that the euro area's economic expansion will keep accelerating, from 1.4 per cent this year to 1.7 per cent in 2016 and 1.8 per cent in 2017. The central bank also saw inflation getting close to its goal near the end of 2017.

Since then, measures of economic activity have worsened and new forecasts to be published after the Dec 3 meeting may be the hook for policy makers to announce more QE.

Should the risks rise further, an extension of QE "would not encounter strong resistance" in the Governing Council, said Anna Maria Grimaldi, an economist at Intesa Sanpaolo SpA in Milan.

"An increase in the monthly target cannot be ruled out, but could encounter substantial resistance within the council and would probably need to be preceded by downward revisions to core inflation forecasts."

BLOOMBERG