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UPDATE 2-ECB's Nowotny calls for new instruments to boost growth, inflation
October 15, 2015 / 9:14 AM / 2 years ago

UPDATE 2-ECB's Nowotny calls for new instruments to boost growth, inflation

* Nowotny says ECB clearly missing its target

* Polls sees extension, expansion of QE

* Fed delay may increase room for ECB (Adds ECB VP, poll, analyst, Fed outlook, upcoming ECB meeting)

By Francesco Canepa and Balazs Koranyi

WARSAW/FRANKFURT, Oct 15 (Reuters) - New instruments are needed to boost growth and inflation in the euro zone, European Central Bank policymaker Ewald Nowotny said on Thursday, suggesting it may be beyond the ECB to achieve its goals using its existing toolkit.

The bloc’s economy is slowing again, with even powerhouse Germany seeing a recent string of poor data, while inflation has returned to negative territory and the euro is uncomfortably strong. That raises pressure on the ECB to make good its promise to expand or extend its trillion-euro-plus asset purchase programme if needed.

“We’re clearly missing our target,” ECB Governing Council member Nowotny said on Thursday. “The ECB is using monetary policy instruments available but in my view it’s quite obvious that ... additional sets of instruments are necessary.”

“These include structural measures ... but also on the demand side of the economy and also on the institutional factors of the economy,” Nowotny said. It was the clearest suggestion yet from a senior policymaker that a wait-and-see approach may be insufficient and that the ECB may not have all the answers.

The euro zone’s central bank is buying 60 billion euros worth of assets -- mainly government bonds -- a month, hoping to boost inflation and growth. But a slowdown in emerging markets, cheap oil and the lingering effects of Europe’s double dip recession are all working against it.

The easiest way to inject further stimulus would be simply to extend the asset purchase scheme beyond its scheduled end next September and analysts polled by Reuters already see a 70 percent chance of such a move.

They expect the bank to have bought 1.52 trillion euros worth of assets by the time the programme is over, a 33 percent increase compared to the current plan.

But a simple increase may be impractical for liquidity and technical reasons, ECB watchers say, meaning it may have to include new asset classes such as corporate debt or stocks, or possibly even municipal debt.

Euro zone inflation is seen at a mere 0.1 percent this year, far off the bank’s target of just under 2 percent and the ECB looks likely to miss its target for years to come.

“In a scenario of prolonged undershooting ... the ECB will need to be open to the idea of taking a longer time to meet the target or reformulating the target,” said Societe Generale analysts. “In case of any shocks, new asset classes will likely need to be purchased.”

German Bundesbank president Jens Weidmann, seen as the ECB’s most hawkish policymaker, has many times argued that the inflation target should be viewed over a longer period, giving the bank some flexibility.

The ECB could cut its deposit rate further, probably weakening the euro, but the benefits would be far outweighed by the loss of credibility associated with breaking its forward guidance that rates have hit bottom, analysts say.

On Thursday, Nowotny also called for fresh measures to boost demand in the 19-country euro zone, improve competitiveness and strengthen economic integration within the currency bloc.

FED

The U.S. Federal Reserve’s decision to delay a widely expected first rate hike since the financial leaves the ECB between a rock and a hard place.

By strengthening the euro against the dollar, it further dampens inflation. But it also takes pressure off emerging markets which are already struggling.

“U.S. monetary policy has large financial spillovers, especially to European bond markets,” ECB Vice President Vitor Constancio said on Thursday. “The evidence even suggests that spillovers from U.S. monetary policy might be larger (for the euro area) than the domestic effects in the United States.”

Futures indicate just a 33 percent chance of a Fed hike in December and a 50 percent chance in March, suggesting a rate increase that almost happened last month may not come until mid-2016.

A Fed hike would have greater global repercussions than in the past because of how the world has adjusted to zero rates, Constancio added, noting that central banks have no experience of reversing such highly accommodative policy.

The first U.S. rate hike for around a decade will have a big impact because emerging markets, particularly China, are more integrated into the global economy than before. Countries are more interlinked in production, cross-border capital flows have increased, and forward guidance has become a crucial monetary policy instrument.

Meeting next week in Malta, the ECB could again tweak its asset purchases but no major policy change is likely before the bank releases fresh quarterly forecasts in December. (Editing by Catherine Evans)

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