A year and a day since the European Central Bank started its unprecedented bond-buying program, adding to an ultra-loose monetary policy that includes negative interest rates, President Mario Draghi is still struggling.
Investors and economists predict yet more stimulus will be announced on Thursday to stave off deflation in the euro area. The rate decision is due at 1:45 pm. in Frankfurt, with Draghi holding a media briefing 45 minutes later. Here are five things to watch for:
Where is the lower bound?
Investors expect at least a 10 basis-point cut in the deposit rate to minus 0.4 percent, as indicated by swaps on the euro overnight index average. Should they be right, attention will turn to whether Draghi will restate his forward guidance to keep interest rates at present “or lower” levels for an extended period.
Doing so might reassure markets that conventional policy tools aren’t exhausted. At the same time, Draghi is likely to be pressured to say where he thinks the lower bound might be. None of the economists surveyed foresees the main refinancing rate being cut from the current 0.05 percent, so any change there would be a surprise.
How should the ECB mitigate the impact on banks?
A negative deposit rate effectively taxes banks’ excess liquidity, yet the ECB is simultaneously pumping money into the financial system via its bond-buying program. It’ll be worried if a squeeze on profitability curbs lending, and Vice President Vitor Constancio and Executive Board member Benoit Coeure have said officials are studying how other central banks mitigate that risk.
So look out for adjustments to the current system. Two-thirds of respondents in a Bloomberg survey predicted a tiered deposit rate, or similar. A straightforward option would be to exempt funds below a certain threshold. That might not be good enough for the euro area though, as banks’ balance sheets and business models differ greatly across the region.
How far can QE grow?
Nearly three-quarters of economists surveyed said the ECB will expand quantitative easing, with the median estimate being an increase to 75 billion euros ($82 billion) a month from the current 60 billion euros. More than a third see Draghi extending purchases beyond the current end date of March 2017, with most saying it’ll be stretched until at least the final quarter of next year.
The issue is whether there’ll be enough bonds to buy. UniCredit SpA analyst Luca Cazzulani estimates that under current rules there is limited scope to expand the program.
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The ECB could relax some of those rules — for example, allowing the purchase of bonds with yields below the deposit rate, expanding the share of any issuance the central bank can buy, allocating national quotas based on outstanding debt rather than economic weight, or adding new asset classes such as corporate bonds or even equities. All those options risk deepening divisions within the Governing Council.
When will the ECB reach its goal?
Draghi will unveil fresh economic projections that for the first time will extend to 2018, and oil’s slump will likely lead to downward revisions from the December outlook when inflation was projected to average 1 percent this year and 1.6 percent in 2017.
Consumer prices slid an annual 0.2 percent in February, so there’s a long way to go to get to the goal of just under 2 percent growth. And that’s a concern for the ECB president and his colleagues. The more they postpone, the weaker their credibility.
What else is on the menu?
Some economists have suggested the ECB could alter its targeted long-term loan program, available to banks that can show they’re expanding loans to companies and households. The TLTRO could be tweaked to make it more attractive, or revised to offset the impact from negative rates.
A broadside at governments is likely — policy makers have long warned politicians that unless they use fiscal space and push through structural reforms, the euro-area recovery will remain purely cyclical.
In short though, be prepared to be surprised. As Draghi said in January: “There are no limits to how far we are willing to deploy our instruments within our mandate to achieve our objective.”
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