22 April 2014

Bloomberg: Draghi gauges Ukraine effect as ECB tackles low inflation

Purchasing managers' indexes are forecast to show growth in manufacturing activity holding at the weakest pace this year. Figures may show declining business confidence in Germany, the region’s biggest economy.

A territorial dispute between Russia and Ukraine, which supply much of Europe’s energy, is undermining confidence in a recovery already threatened by a strengthening currency and subdued pricing power. That raises the prospect of ECB officials being called on their promise to ease monetary policy if needed, including with unconventional tools such as quantitative easing.

Tension in eastern Europe "could easily spark turbulences big enough to temporarily halt the eurozone recovery", said Christian Schulz, senior economist at Berenberg Bank in London. "It is the biggest risk to our optimistic growth forecasts for the euro zone at the moment."

Against the backdrop of continued tensions in Ukraine, gauges of sentiment in the euro area may show signs of caution. A gauge of consumer confidence was probably unchanged in April after fluctuating in the first three months, according to a Bloomberg survey of economists.

Germany’s Ifo index of business confidence is predicted to drop to 110.4 in April from 110.7 the prior month, according to the median estimate in another survey. The reading declined in March for the first time in five months. The ZEW (GRZEWI) Center for European Economic Research in Mannheim said last week that its index of German investor confidence fell for a fourth month in part because of the Ukraine conflict.

Mario Draghi said on 3 April that his "biggest fear" is a protracted stagnation in the euro area. Addressing the IMF in Washington this month, he reiterated that policy makers are "resolute" in their determination to keep monetary policy loose and unanimous in their commitment to use unconventional instruments within the ECB’s mandate if needed. The central bank has kept its benchmark interest rate at a record-low 0.25 per cent since November.

While Draghi’s comments open the door to quantitative easing, an imminent announcement is unlikely. ECB Executive Board member Benoit Coeuré said in Washington that the fragmented euro area means the large-scale bond purchases favored by the Federal Reserve, Bank of England and Bank of Japan may not be appropriate.

ECB Options

"There is no single yield curve that refers to a 'commoditised' reference asset and that is equally relevant for loans to firms and households", he said. "Creating such an asset would ease the implementation of our monetary policy, but this cannot be a short-term project."

That leaves the ECB with options including another cut in the main refinancing rate, taking the deposit rate below zero for the first time, and liquidity operations such as offering more long-term loans to banks. The Governing Council’s next meeting to set monetary policy will be on 8 May in Brussels.

Asset purchases have also been discussed by the 24-member council. While the details of any plan are unknown, options range from smaller programs targeting a specific class of securities to an across-the-board mix of private and public debt.

Draghi said in Washington that a stronger euro is undermining the fight against low inflation and a further appreciation could trigger more stimulus. The single currency has gained 5.7 per cent against the dollar in the past 12 months, curbing the price of imported goods and the competitiveness of the region’s exporters.

"The ECB hopes that monetary policy in the euro zone will become very boring very quickly", said Richard Barwell, senior economist at Royal Bank of Scotland Group Plc in London. "But April inflation will be critical looking forward. If it doesn’t bounce, it’s the thing that might force them to act."

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