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10 Jul 2013

What’s left in the ECB toolkit?

Janet Henry

by Janet Henry

Chief European Economist, HSBC

What’s left in the ECB toolkit? (Getty Images/Alessandro Contadini)

The eurozone’s political and economic challenges remain enormous. Yet with the US Federal Reserve talking about starting to normalise monetary policy, the European Central Bank’s (ECB) task of keeping its policy appropriately loose has got harder.

Eurozone growth is still not coming back, unemployment rates are rising to socially unacceptable levels and debt projections continue to be revised up. The limits to austerity are being reached and populations and politicians are becoming more vocal in saying so.

But while austerity fatigue is setting in, so is the willingness of the stronger eurozone countries to sign up their taxpayers to further cross-border support. This is evident in the slow progress on banking union. The link between banks and sovereign nations has still not been severed so the fragmentation of monetary conditions is likely to persist and continue to hamper the ECB’s ability to set monetary policy.

The limits to austerity are being reached and populations and politicians are becoming more vocal in saying so

So it is unfortunate that Fed tapering talk has pushed up European bond yields when monetary conditions need to remain exceptionally loose.

There have been tentative signs of stabilisation, or at least less deep recessions, in most of the eurozone and indicators suggest export orders for Spain and Italy have recovered strongly. However, our latest forecasts expect GDP growth of just 0.6 per cent in 2014 (the ECB is looking for 1.1 per cent), reflecting lower projections for the core countries – even Germany, thanks to our reduced forecasts for China’s growth.

Our growth projections for most of the eurozone will do little to stabilise government debt-to-GDP ratios any time soon, or to revive inflation, which we expect to trend lower.

Unlike the Fed, the ECB is nowhere near the exit. Mario Draghi, the ECB President, has said interest rates will remain “at present or lower levels for an extended period” – a significant change of tack for a central bank that always used to say it “never pre-commits”. Like the Bank of England, the aim seems to be to try to talk the market into reversing some of the increases in short-term interest rates, but without giving specific times or thresholds for when policy might eventually be tightened, qualitative forward guidance risks making the market more uncertain about the central bank’s reaction.

While we expect this year’s ECB measures will be more about a refinancing rate cut, more forward guidance and more liquidity, ultimately we believe quantitative easing will have to be considered if the bank fears it will miss its price stability mandate on the downside.

Private-sector asset purchases could potentially be more effective at helping banks to deleverage and reduce their cost of funding. But with a fully developed asset-backed securities market for small company loans still a long way off and no genuine banking union in place, such a policy would be hard to implement and would potentially go well beyond the remit of the ECB.

This research was first published on 8 July 2013.

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