08 March 2019

Financial Times: The European Central Bank is attempting to get ahead of events

The ECB’s U-turn this week — reviving part of its stimulus programme after two years of weaning the eurozone off easy money — took markets by surprise. But signs of eurozone weakening, especially in Germany, and in key partners such as China, had been evident for months, the FT points out.

Once the US Federal Reserve signalled a pause before lifting rates again, the ECB became likely to follow suit. In his final months in the role, ECB president Mario Draghi is clearly trying to get ahead of events. Less clear is whether the bank has done enough, or has the means to do so, if the weakening continues.

The ECB’s downgrade of its eurozone growth forecast this year to 1.1 per cent, from 1.7 per cent just three months ago, reflects the scale of the uncertainties. Expectations of a strong expansion in the US this year have been scaled back. China, at its National Policy Council this week, lowered its target for economic growth in 2019 to a range of 6-6.5 per cent, from a hard target of 6.5 per cent in the past two years — in part because of its economic and trade frictions with the US.

Despite signs that Washington and Beijing might be near an agreement to end their current spat, trade tensions could easily flare elsewhere. The risk remains that US president Donald Trump might slap tariffs on cars and components from the EU, dealing a severe blow to the German and broader European economy. As the UK parliament prepares for crucial Brexit votes next week, a calamitous no-deal crash-out from the EU can still not be ruled out.

In response, the ECB has promised to keep interest rates at their current record low until at least 2020. While it stopped expanding quantitative easing in December, it has indicated it will keep constant the amount of financial securities it acquired under QE until after rates begin to rise. Taken together, that constitutes a delay to the moment when “quantitative tightening” will finally begin.

By promising a new round of cheap long-term loans to banks willing to expand lending, moreover, the ECB will enable Spanish, Italian and other banks to roll over funding they have already received, some of which is set to mature.

Such measures are sensible and welcome. If risks are contained and the economy stabilises, they may be sufficient. But the combination of persistently low core inflation and weak growth leaves the eurozone highly vulnerable. One sizeable negative shock could tip it again into recession, with knock-on effects that could once more strain the integrity of the single currency. Even while hoping for the best, therefore, eurozone authorities must prepare for the worst — to ensure rapid action can be taken if required.

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