ECB to give euro zone economy a small shot in the arm

[VILNIUS] The European Central Bank will try to give an ailing euro zone economy a boost on Thursday and may even set the stage for more action later this year as an escalating global trade war saps growth and unravels the benefits of years of ECB stimulus.

With pervasive uncertainty already denting trade, big central banks like the ECB and the Federal Reserve appear to have given up plans to tighten policy, and markets are now positioned for easing.

In a long-flagged move, the ECB will likely offer to pay banks if they borrow cash from the central bank and pass it on to households and firms.

ECB President Mario Draghi is not expected to do much more than that because he will want to keep some measures in reserve as the economic outlook darkens.

Mr Draghi is certain to maintain a dovish tone though, leaving open the possibility of more stimulus and the prospect of a further delay in the bank's first post-crisis rate hike.

But the Italian, who leaves his post on Oct 31, cannot afford bigger moves for now as the ECB's policy arsenal is near depleted after years of stimulus.

While policymakers say they have plenty of tools left, they have already pushed their main interest rate below zero and bought some 2.6 trillion euros (S$4 trillion) worth of bonds, meaning the scope for more stimulus has shrunk, especially in the case of imported economic weakness.

"Policy ammunition is limited and it would make sense for the ECB to keep its powder dry now, saving it for any potential adverse shocks that might come along," BNP Paribas economist Luigi Speranza said. "Draghi's term is coming to an end and the Council may be reluctant to tie the hands of his successor."

The ECB, which meets in Vilnius, announces its interest rate decision at 1130 GMT, followed by Mr Draghi's 1230 GMT news conference.

Economists polled by Reuters expect rates to stay unchanged on Thursday and expect a first rate hike only in 2021. They also expect the bank's next move to entail policy easing rather than tightening.

RISKS

Mr Draghi's problem is that a global trade war is showing no signs of dissipation, Italy is once again in conflict with the European Commission, German industry is continuing to post dismal figures, stocks are tumbling, and the threat of a hard Brexit looms large.

And on top of it all, inflation expectations, the ECB's top worry, are steadily declining, raising the risk that they become dislodged, thereby perpetuating weak price growth.

Indeed, in Philip Lane's first policy meeting as chief economist, the ECB is expected to cut some of its inflation projections, reinforcing already widespread concerns that price growth is too weak.

"A big cloud hanging over the ECB Governing Council is the visible decline in market-based inflation expectations," UBS economist Reinhard Cluse said. "We would not rule out the ECB changing its interest rate forward guidance again this week, although this is not our base-case scenario."

The ECB targets an inflation rate of just below 2 per cent, but it has undershot this since 2013 and projections suggest it will continue to miss it for years to come.

Mr Draghi is also expected to stick to his message that the economy's rebound is merely delayed and not derailed.

But some may be losing confidence since record high employment, solid wage rises and several years of unexpectedly good economic growth failed to boost prices.

"Easy monetary policy will be needed for a long time, and the risks remain clearly tilted to the downside," Nordea economist Jan von Gerich said.

REUTERS