ECB to unveil fresh stimulus to lift sagging economy, inflation

[FRANKFURT] The European Central Bank is set to unveil its second economic stimulus cocktail in three months on Thursday, spurred by fears that low energy costs are feeding into wages and prices, potentially perpetuating ultra-low inflation.

The eurozone's central bank is widely expected to cut its deposit rate deeper into negative territory, adjust its 1.5 trillion euro asset-buying scheme and may even consider measures to prop up banking margins, hoping to boost prices after inflation dipped back into negative territory last month.

The ECB has little to show for the 700 billion euros it has spent buying government bonds and other assets in the past year, as tumbling raw materials prices blunt the impact of its quantitative easing.

That raises the risk that people will lose faith in the bank's commitment to its mandate. Inflation has been below the ECB's nearly 2 per cent target for three years and is likely to remain so for many more.

"The stakes are high at (Thursday's) ECB policy meeting, given the disappointment in December and the fundamental questions now being asked about the efficacy and limits of monetary policy," JPMorgan economist Greg Fuzesi said. "Crucially, it is no longer just a small minority of ECB governors who regard the remaining policy tools as problematic. Markets have also raised some concerns," Fuzesi added.

Draghi has already said that acting too soon is better than acting too late, and that the rate meeting needs to recognise that the outlook for growth and inflation have deteriorated.

But with policy already deep in unconventional territory, the ECB has few big guns left and most remaining options risk either negative side effects or potential legal challenges, suggesting the Governing Council will opt for a package of modest measures.

Analysts polled by Reuters expect the ECB to cut its deposit rate to -0.4 per cent from -0.3 per cent, charging banks more for keeping their cash with the bank overnight. They also see a 60 per cent chance the ECB will raise its monthly asset purchases, probably by 10 billion euros to 70 billion euros a month.

It could also firm up its forward guidance, drop a self-imposed limit not to buy assets yielding less than its deposit rate and launch a new targeted longer-term refinancing operation, possibly at a negative rate, to help boost lending, growth and eventually inflation.

The ECB could also unveil measures to prop up bank margins after two board members said they would look at what other countries have done, including two which have introduced multi-tiered deposit rates to partially shield bank from negative rates. "In looking at what can be done if we decide to ease a little further, we will have to mitigate the effect of that on banks as other countries have done - Switzerland, Japan, and so on," ECB Vice President Vitor Constancio said recently.

Other ideas - such as a deeper rate cut, equity purchases or buying non-performing bank loans - are less likely to gain traction within the diverse 25-member Governing Council that has shunned radical steps in several earlier tweaks of its asset-buying programme.

But policy easing may face less resistance than in December as its rotating voting rights mean several hawks, including Bundesbank President Jens Weidmann, will not get to vote this time.

"Eventually 'whatever it takes' may require the ECB to redesign the public sector purchase programme and relax its current constraints," RBS analyst Marco Brancolini said, referring to Draghi's promise to do everything to preserve the euro. "We think everything must be, and will be on the table."

Releasing fresh inflation and GDP forecasts, the ECB may also take comfort in a relatively benign economic outlook. Growth in 2015 actually beat its expectation, consumption is holding up and German industrial production surged in January.

A rebound in global markets since the lows of January is also a relief for the ECB, easing the need for a big move.

Oil prices are up more than 40 per cent from early year lows and iron ore has risen 66 per cent. Eurozone bank shares are still down 15 per cent on the year but they are 20 per cent above February lows, suggesting market sentiment has stabilised.

REUTERS