IMF urges ECB to maintain stimulus amid downside risks to growth

[FRANKFURT] The International Monetary Fund warned of significant downside risks to the euro area's economic outlook and urged the European Central Bank to keep stimulus in place amid weak price pressures.

"Monetary policy should remain firmly accommodative until there is a sustained rise in the inflation path toward the ECB's price stability objective," the Washington-based lender wrote in a report published Tuesday. It also said that some countries will have to tolerate inflation above that level for a "prolonged period" to lift the average in the 19-nation euro area.

While the ECB's assessment of the economic outlook is slightly more optimistic - it says risks are broadly balanced - officials agree that the region continues to need central-bank support. The Governing Council has deferred a decision about the future of asset purchases until autumn, with President Mario Draghi arguing that persistence, patience and prudence are needed to allow record-low interest rates and unconventional policies to work.

The IMF said the euro area's cyclical recovery is "firming and becoming broad based" as lower energy prices, stimulus, stronger labor markets and a recovery in credit boost domestic demand. It predicts economic growth of 1.9 per cent this year and 1.7 per cent in 2018. Inflation is seen slowing to 1.5 per cent in 2018 from 1.6 per cent this year.

Downside Risks

"The improving near-term outlook is clouded by significant downside risks, especially in the medium and long term, amidst thin policy buffers," the IMF said.

"Some high-debt countries could experience rising borrowing costs in the face of tighter global financial conditions or reduced monetary accommodation." 

Warning of structural weaknesses in the region's banking system, the IMF also stressed that the UK exit from the European Union is likely to transform the bloc's financial landscape, with transaction costs potentially rising during the transition process, though that impact will probably be "modest".

"The EU will need to work on strengthening oversight and regulation to handle a greater volume of financial transactions and mitigate risks," it said, adding that uncertainty related to the Brexit negotiations risks damping investment and consumption in some countries. 

The IMF also highlighted that trade imbalances and differences in income could hurt political support for more European integration and that a "global slowdown stemming from a rise in protectionism" could weigh on the recovery.

It encouraged governments to accelerate reforms at both the national and central level and complete the banking union, including a common deposit insurance and a common fiscal backstop. Countries with fiscal leeway should use it to support public investment and structural reforms that boost potential growth, it said, while others should reduce their debt load. All countries should make fiscal policy more growth friendly, according to the IMF.

BLOOMBERG