Central Banks

ECB set to hold steady amid heightened economic risks

Mario Draghi, president of the European Central Bank (ECB), looks on during the 'ECB and its Watchers' conference in Frankfurt, Germany, on Wednesday, March 27, 2019.
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The European Central Bank is in an uncomfortable situation. It only announced its exit from the crisis-era multi-trillion bond buying program at the end of last year. However, only four months later there is more and more evidence that the economy is only having a temporary weakness as data across the board comes in lower than expected.

"The euro zone purchasing managers' index (PMI) indicated a sluggish end to the first quarter with growth ebbing to one of the most lethargic rates seen since 2014," Chris Williamson, chief business economist at IHS Markit wrote in a global economy report Tuesday. "The slowdown was led by a deepening downturn in manufacturing, where output fell at the sharpest rate for almost 6 years."

That's a problem for the ECB, as slower growth and demand will not help to bring inflation back toward their target of 2%. A rate hike is not expected for this year and there is even a growing debate to lessen the burden on banks from the negative deposit rate.

"We have pushed back our first rate hike to October 2020," Dirk Schumacher, ECB watcher Natixis in Frankfurt said in a note. "We expect the ECB to introduce a tiering system for banks' excess liquidity, reducing the pressure to lift rates out of negative territory."

A so called two-tiered approach would mean that banks are exempted in part from paying the ECB's 0.40% annual charge on their excess reserves. That would boost the banks' profits at a time many lenders struggle with low profitability. Some members of the ECB's Governing Council are said to be in favor of such a move.

"Tiering won't be a silver bullet for banks or the economy but is likely to form part of a credit easing strategy alongside adjusted forward guidance, strong use of (targeted long-term refinancing operation) TLTRO - III's "built in incentives", and possibly some new tools," Marc Wall, chief economist at Deutsche Bank said in a note last week. "The next most likely occasion for policy announcements is June. The details will be conditioned on the new ECB macro forecasts."

The TLTROs are loans that the ECB provides at cheap rates to banks in the euro area. As a result, lenders are able to provide better credit conditions to customers, which in turn stimulates the real economy.

TLTRO III is the third injection of stimulus of this kind from the ECB, announced in its policy meeting in March. If commercial banks lend this money onto the real economy, they then receive cash rather than having to pay interest on the loans.

Last June Draghi announced its big exit strategy. It would be ironic if only a year after, he would have to announce new easing measures.