European Central Bank Facing Continuing Challenges

European Central Bank Facing Continuing Challenges

European Central Bank Facing Continuing Challenges

The European Central Bank (ECB) facing continuing challenges when its Governing Council meets Thursday in Estonia.

The Eurozone’s central bank is likely to err on the side of prudence by avoiding any notable reduction in monetary stimulus, even though the arguments points to a different policy direction.

The argument for some reduction in what has been significant and prolonged ECB stimulus is based on 6 realities as follows:

  1. The Eurozone is experiencing higher economic growth, with less dispersion among its member countries.
  2. Forward-looking indicators point to further growth acceleration in the months ahead.
  3. Financial conditions overall have eased, both in Europe and in the rest of the world.
  4. The risk of geopolitical shocks has diminished with the passing of the Dutch and, especially, French elections.
  5. The currency has strengthened Vs the USD, raising the potential of growth headwinds down the road.
  6. There are growing political pressures to curtail the ECB’s prolonged use of unconventional policies.

The ECB looks to be in no rush to tighten monetary policy. Inflation is still too low for its liking and some officials there still remember the premature tightening of Y 2011. And there are concerns about possibly destabilizing Italy in the run-up to elections there.

The mechanics of an ECB policy tightening at this stage are complicated.

Forward policy guidance has committed the ECB to substantial asset purchases of $68-B a month until the end of Y 2017. Any changes could diminish the effectiveness of this policy tool in the future.

Raising interest rates while maintaining these monthly purchases is neutral.

Facing this reality, the ECB Thursday will most likely revise upward its economic assessment but leave its policy stance unchanged, meaning it will announce no reduction in its asset purchase program and no hike in interest rates.

Noted economist Mohamed A. El-Erian says, that “…the ECB would be well advised to signal, at the minimum, its intention that, at the September Governing Council meeting, it would be inclined to gradually move away from a policy stance that has bought the region important time but has not dealt, and cannot deal, with many of its growth impediments. These issues are solvable if politicians step up fully to their economic governance responsibilities.”

Stay tuned…

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