Thursday, Oct 23, 2014

European Central Bank getting closer to Fed-style stimulus measures

Associated Press | Frankfurt | Posted: June 8, 2014 2:52 am

The European Central Bank (ECB) has deployed a raft of aggressive measures to boost Europe’s economy, but stopped short of the one many economists insist would do the most to help: large-scale purchases of bonds. That could change sooner rather than later, analysts say, if inflation remains low.

Purchases of bonds using newly created money — called quantitative easing — have been used with some success so far by the US Federal Reserve, the Bank of England and the Bank of Japan. They can reduce market interest rates, making it cheaper for consumers and businesses to borrow, helping growth.

So why not in Europe?

To begin with, the ECB faces technical and practical challenges that other major central banks don’t have. It has 18 different government bond markets, raising the question of whose bonds to buy and how many.

Beyond that, creating new money has long faced resistance in Germany, the biggest economy in Europe where central bank stimulus measures are looked upon with suspicion and have a prominent place in public discussion.

But after Thursday’s meeting, things could be shifting. At a press conference on Thursday, ECB President Mario Draghi held the door open to such bond purchases, suggesting Germany has at least softened its outright resistance. If inflation falls further, analysts think the ECB could start quantitative easing.

“Are we finished?” he said after the decision. “The answer is no.”

The ECB is keen to bring up the inflation rate, which at 0.5 per cent is so low it raises fears the euro zone will fall into outright deflation, a crippling downward price spiral. The antidote is to take steps to encourage borrowing and lending and increase the amount of money circulating in the economy.

Analysts Joerg Kraemer and Christoph Weil at Commerzbank see a 40 per cent chance the ECB will engage in quantitative easing and say speculation will be “constant” in the wake of Thursday. On balance, they expect that the measures the ECB announced will be just enough for the ECB not to have to resort to quantitative easing. If inflation keeps falling short of expectations, however, they say the ECB is more likely than not to start bond purchases.

Among the list of measures the ECB did take on Thursday was an offer of long-term, cheap loans to banks on condition they lend to companies.

That condition aims at making sure the money gets to the economy and helps create growth and jobs. The ECB also cut the rate at which it loans to banks to 0.15 per cent from 0.25 per cent and imposed an unusual negative interest rate of 0.1 per cent on deposits from banks — an incentive for them to loan those excess funds.

Significantly, Draghi said that rates have gone about as low as they can. Typically, central banks must first use up their conventional forms of stimulus before engaging in something as drastic as large-scale bond purchases.

That opens the door wider for large-scale bond purchases.

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