ECB seen on hold as inflation picks up, QE a way off

Tuesday 06 May 2014 12.45
No rate changes from ECB expected this week
No rate changes from ECB expected this week

The European Central Bank will likely hold off policy action on Thursday, waiting for new forecasts from its staff in June before deciding whether to counter low inflation that moved up slightly last month.

The ECB Governing Council meets in Brussels against the backdrop of a Franco-German spat over ECB policy towards the euro's exchange rate.

This is one factor the bank's president, Mario Draghi, has identified as a potential trigger for policy action. 

Last month, Draghi outlined scenarios that could prompt the ECB to act: a tightening of monetary policy caused by market moves like further euro gains, fresh trouble transmitting ECB policy to all parts of the euro zone, or a deterioration of the inflation outlook. 

None of the scenarios appears to have materialised to a sufficient degree yet to prompt ECB action.  

A Reuters poll published on Friday showed euro zone monetary policy is likely to remain steady well into the future as a more broad-based recovery takes hold while inflation has probably already fallen as low as it will go. 

With inflation running well below its target of just under 2% over the medium-term, the ECB has nonetheless faced calls from French politicians and the International Monetary Fund to do more to buoy the euro zone economy.

Germany yesterdsay said the level of the euro was an issue for the ECB but not politicians, indirectly criticising French Prime Minister Manuel Valls after he said the currency was "too high" and that a "more appropriate" monetary policy was needed to bring it down. 

Markets are looking for any sign the ECB could embark on US-style quantitative easing (QE) - central-bank speak for money printing to buy assets. They are likely to be waiting for some time.

Draghi raised the idea in an April 24 speech of a "broad-based asset purchase programme" if the inflation outlook worsens. But just a few days later - at a meeting with German lawmakers - he played down the prospect of QE any time soon. 

The ECB chief did see "a problem of ongoing low inflation rates, which could lead to measures", a source who attended the meeting said, adding: "He mentioned quantitative easing in this context but made clear that we're still some way off QE."

While the ECB is far from embarking on a broad asset-buying plan, it is closer to readying a targeted funding operation that would seek to encourage banks to lend to small and medium-size businesses, or SMEs.

Such an operation could see the ECB offer banks cheap, long-term loans, or LTROs, in return for collateral in the form of bundled loans to SMEs - a ploy that would aim to support the market for SME loans packaged as asset-backed securities (ABS). 

If banks responded to the offer, such a measure could give the smaller companies that form the backbone of the euro zone economy better access to credit and allow ECB policy rates to filter through to them more efficiently.

The ECB supplied banks with over €1 trillion in 3-year LTROs in late 2011 and early 2012, as the euro zone crisis was choked lenders.

A targeted LTRO would lack the size, scale and impact of a major asset-buying plan, and some analysts doubt whether it would do much to address the low inflation gripping the euro zone now. 

No ECB action this month would stoke market anticipation of updated forecasts from the bank's staff, stretching through to 2016, which it will publish after its June 5 meeting. 

A downward revision of the inflation forecasts then would put renewed pressure on the ECB to act, while an upward revision would relieve some pressure.