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ECB 'playing for time' after disappointing December

The European Central Bank (ECB) headquarters is pictured in Frankfurt, Germany, September 3, 2015.
Ralph Orlowski | Reuters

With little signs of inflation picking up, disappointing industrial production numbers and slow growth, analysts are questioning whether the European Central Bank (ECB) could signal more stimulus when it meets this coming week, having sorely disappointed markets last month.

In December, the ECB failed to meet market expectations for the bank to strengthen its quantitative easing (QE) program. It opted instead to widen the range of asset purchases it makes, extend the duration of the program to March 2017 (and possibly beyond) and announced a slightly more modest deposit rate cut. The current negative deposit rate effectively means euro zone banks are being charged to park cash at the central bank.

During the December press conference, ECB President Mario Draghi defended the package as "adequate", arguing that size and composition had been carefully calibrated by the central bank. Still, with investors expecting more and having their hopes dashed, there was a sell-off in European equities following the meeting.

Defending the central bank, ECB Vice President Vitor Constancio told CNBC in December that "the markets got it wrong in forming their expectations" and he rejected the view that the ECB had lost some credibility over its forward guidance.

"After our meeting in October we said that we would reassess the degree of accommodation so we were talking about a recalibration of our measure. We were not talking about, ever, about a new type of QE2 or something like that. That's not what we were talking about," he told CNBC in Frankfurt.

There was speculation that the ECB tempered its announcements due to pushback from hawks, such as Jens Weidmann, on the bank's governing council who are opposed to expanding the bank's balance sheet.

Willing to change?

While the bank resisted extending its monetary policy aggressively in December, minutes of the bank's meeting released on Thursday signaled that some members of the governing council wanted the bank to act further, calling for a 20 basis point cut to its deposit rate instead of the 10 basis point cut decided upon.

Importantly for markets too, the governing council said that when assessing the options open to it – such as whether to expand the monthly volume of purchases -- there was "broad agreement that such measures would not be warranted at this juncture, while a reassessment could be made in future," meaning that the bank has not ruled out the prospect of more stimulus.

Indeed, the ECB might take a look at the changing macro-economic environment and take a different view of what is needed for the euro zone. As Greg Fuzesi, an economist at JP Morgan, said in a note ahead of the minutes "since December, the macro data has moved on significantly."

Not only have oil prices fallen further with benchmark Brent crude falling below the $30 a barrel mark this week, which makes the ECB's 2 percent inflation target even more of a distant reality, but concerns over a slowdown in China have become more acute as market volatility unfolded last week.

Things are looking uncertain in the ECB's own backyard too, with industrial production in the euro zone falling sharply in November. To be specific, Eurostat said that output declined by 0.7 percent in November from the previous month, largely due to the production of energy, capital goods and durable consumer goods falling. The number could have an impact on the 19-country currency bloc's growth figures for the final quarter of 2015.

Playing for time

Despite the macro-economic environment deteriorating, analysts expected the central bank to stand pat on its current policy for now.

"We do not currently have more ECB easing in our forecast, but will assess this again on Thursday (following the minutes)," Greg Fuzesi, an economist at J.P. Morgan said.

"As noted before, there was a strong case for the ECB to do more even ahead of the latest market turmoil, especially because core inflation is unlikely to match the steady increases projected by the ECB staff. There have now been two consecutive disappointments on core inflation since the staff finalized its December projections, even if some of this may be weather-related," Fuzesi said.

"But, equally, the ECB may want to play for time if it is not willing to consider faster-acting options (such as deeper deposit rate cuts or a faster monthly QE pace). In this regard, (ECB Executive Board member) Peter Praet's comments last week hinted at some acceptance of a slower return to the (inflation) target in the event of commodity price weakness, which we note complicates the timing of any further response."