ECB set to sketch path for new stimulus

Financial markets already expect the ECB to trim key rates at its policy meeting in September AFP/Daniel ROLAND

Expectations for a possible cut at the summer gathering have been heightened in recent weeks by the ECB itself talking up the possibility of action.

In June, ECB president Mario Draghi made clear that "in the absence of improvement ... additional stimulus will be required", meaning the institution will not wait for economic conditions to worsen before acting.

While highlighting a resilient domestic economy, members of the ECB governing council in Frankfurt will keep a close eye on risks outside the single currency area.

These include US-led protectionism, the danger of a no-deal Brexit, weakness in emerging markets and geopolitical risks, such as growing tensions with Iran around key Gulf shipping routes.

Surveys have for months pointed to an economic slowdown in the second and third quarters from the 0.4 per cent growth booked in January-March.

Slower growth in turn threatens the central bank's inflation target of just below 2.0 per cent.

Inflation came in at 1.3 per cent in June.

This week, "it seems as if the ECB will try to talk a very final talk before walking the walk" of rate cuts or even more drastic measures at its September meeting, ING economist Carsten Brzeski said.

FURTHER BELOW ZERO

Pictet Wealth Management strategist Frederik Ducrozet said "the most natural path" for the ECB's policymakers would be opening their "forward guidance" policy statement to the possibility of lower rates.

In June, the ECB had said rates will "remain at their present levels at least through the first half of 2020".

Markets expect a cut at the September 12 meeting of 0.1 percentage point, taking the amount lenders must pay on their deposits with the central bank to 0.5 percent.

Negative rates are designed to prod the financial system into lending and investing cash in the real economy, rather than parking it safely with the central bank or in government debt.

A step lower in September -- after an expected rate cut from the US Federal Reserve at the end of July -- could help restore confidence in the ECB's room for manoeuvre.

But the Fed is set to remain in positive territory, while European banks have long grumbled at their negative rate burden, saying it undermines their business model.

Such harm could be softened with a "tiering" system to exempt some deposits from the harshest negative rate, as central banks in Sweden, Switzerland, Denmark and Japan have introduced, Ducrozet said.

Some analysts argue that the ECB could again unsheathe its other principal crisis-fighting weapon, mass "quantitative easing" (QE) purchases of government and corporate bonds, as early as September.

Net bond purchases under the scheme were brought to an end in December, although the central bank continues to reinvest the proceeds of its 2.6-trillion-euro ($2.9 trillion) stock of bonds.

- 'Proactively responding' -

Recent comments from some senior ECB policymakers could even suggest action sooner.

"It is essential that a central bank shows consistency in its monetary policy decisions by proactively responding to shocks" that could distance it from its inflation target, recently-installed chief economist Philip Lane said in early July.

Pictet's Ducrozet said that "there is no obvious justification for waiting until September" -- even if in the past the ECB has usually waited for the publication of its in-house economic forecasts each quarter.

While the US and the EU have put their trade dispute on ice for now, knock-on effects from Washington's battle with China, in particular, continue to weigh on eurozone industry.

Along with other factors, that has prompted the ECB to repeat that "risks surrounding the euro area growth outlook remain tilted to the downside".

With the ECB's new president, Christine Lagarde, set to take over on Oct 31, "the risk ... remains that Mario Draghi will try to surprise financial markets" before his departure, ING's Brzeski said.

"It would not be the first time."