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Italy is threatening to unravel the relative calm that Draghi’s pledge to safeguard the euro brought to markets last year. With the 17-nation currency bloc struggling to exit recession, the ECB could be forced to lower its economic forecasts today. At the same time, the euro’s recent decline might ease concern that inflation will drop too far below the central bank’s 2 percent target. Policy options available to the ECB include rate cuts, more long-term loans to banks, and measures to encourage bank lending to small and medium-sized companies that are struggling to gain access to credit.
Banks have started to repay the ECB’s three-year loans, or Longer-Term Refinancing Operations, which were designed to prevent a credit squeeze and encourage lending. That’s pushed up borrowing costs in financial markets and sparked concern about a premature tightening of monetary conditions.
At the same time, concern about the side-effects of expansionary policy is growing at the ECB. Executive Board members Peter Praet and Yves Mersch last week warned of the risks in leaving emergency stimulus in place for too long.