Negative rates? More QE? What's in Draghi's bazooka?

The European Central Bank (ECB) looks set to deliver yet more monetary stimulus next week amid growing criticism of how the world's central banks are handling monetary policy.

At the bank's last monetary policy meeting in January, President Mario Draghi announced that the Governing Council would review and possibly reconsider its stimulus program in early March. On Tuesday, the Italian highlighted increasingly weak inflation trends for the euro zone which only added to expectations that the ECB is ready to act.

"It's likely to be more proactive. I suspect we will see more out of the ECB than we have so far. And (Draghi) will do more," Mohamed El-Erian, chief economic advisor at Allianz, told CNBC at the Global Financial Markets Forum in Abu Dhabi. when asked about the ECB's next meeting on March 10.

A poll of 18 euro money market traders by Reuters on Monday indicated that all now believe the bank will cut its deposit rate further into negative territory. It also showed many thought an increase in its monthly bond-buying program - currently at 60 billion euros ($65 billion) a month - could be on the cards.

Mario Draghi
Ralph Orlowski | Reuters
Mario Draghi

Negative rates - effectively charging banks that deposit money - and quantitative easing - buying up bonds from banks -- are both designed to free up funds for the banks to invest in loans and mortgages and get the euro zone economy moving again.

Traders might believe the ECB will act but remain skeptical whether it will actually make a difference. The five-year, five-year breakeven forward rate, which measures where markets see inflation forecasts five years from now, recently hit its lowest since Reuters started tracking the metric back in 2012.

Negative rates have been a hot topic this year. Some analysts believe it is a de facto tax on the banking system that compresses their margins. Indeed, the Euro Stoxx 600 banking benchmark has fallen 15 percent year-to-date amid wider concerns of the quality of the lender's balance sheets.

Research from RBC Capital Markets this week claimed that the banking system in Europe will become increasingly stressed as a response to negative interest rates. In a note released on Wednesday, the company predicted a small deposit rate cut next week but added that it cannot rely on ever more negative short term rates and called for other forms of "credit easing."

Central Bank Outlook
What's on the table for the ECB?   

Meanwhile, Antonin Jullier, global head of equity trading strategy at Citi, believes market participants are pricing in a 10 basis point ECB deposit rate cut next Thursday, taking it down to -0.40 percent, and told CNBC Thursday that he prefers U.S. banks over European banks in this current environment.

El-Erian is also wary of a negative interest rate policy for Europe, telling CNBC that the Bank of Japan has found a "preserve reaction" with its currency strengthening and stock market falling. "I hope there is a handoff somewhere to a more comprehensive policy response (from the ECB)," he said.

Policymakers at the Frankfurt-based institution have countered this argument on negative rates, including Executive Board member Benoit Coeure. He told a conference in Germany this week that banks had already dealt well with rock bottom interest rates and their biggest problems are not being caused by loose monetary policies, according to Reuters.

Draghi and his lieutenants will no doubt echo those sentiments next week but might find it harder to combat a more general criticism of global central baking. For example, Former Bank of England Governor, Mervyn King, believes that stretched central banks have taken monetary policy to its limits, according to a serialization of his new book this week.

Elsewhere, Jacob Frenkel, the chairman of JPMorgan Chase International and a former governor of the Bank of Israel, has similar concerns. Speaking to CNBC in Shanghai ahead of a G-20 meeting of the finance ministers last Friday, he said that central banks had already become "overwhelmed and overstretched."

The ECB's next rate decision is due on Thursday, March 10.

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