G7 finance ministers and central bank heads may not have officially agreed to a synchronised monetary response at last week’s conference call, but the US Federal Reserve’s 50 basis point inter-meeting cut has made the issue of coordination moot.
Prior to the recent severe worsening in the coronavirus risk due to outbreaks in Europe and elsewhere globally, the eurozone economy was already in a delicate spot and the German economy was teetering on the brink of recession.
The developments of the past two weeks, including last week’s 50 basis point cut from the Federal Reserve, have tightened eurozone financial conditions, and are likely to prove the final straw for the ECB, which will be forced to ease monetary conditions substantially at Thursday’s meeting, which will be the first high-stakes decision for Christine Lagarde as President.
Graph: Eurozone financial conditions tightening places pressure on ECB
Likely and possible measures at Thursday’s meeting:
- A 10bp rate cut has been almost fully priced in by OIS markets, and we believe the ECB will deliver this measure, even if its marginal effectiveness in stimulating the real economy may be low. Holding rates unchanged would further tighten financial conditions, which have contracted due to falls in equity prices and widening spreads between sovereign debt and interbank lending rates. The euro has also appreciated significantly in recent weeks, and a hawkish surprise would exacerbate this move.
- The ECB is also likely to take additional measures to support lending to non-financial corporates. These measures may include attempts to encourage banks to increase lending, such as increasing the amount of reserves exempt to the ECB’s lowest deposit rate, and measures to broaden the uptake of targeted long term refinancing operations.
- Expanded sovereign asset purchases are not likely to be used at this meeting, in our opinion. The ECB’s current asset purchase programme is constrained by the issuer limit, and the capital key. Loosening either would cost Lagarde political capital that, in our view, would be better spent making calls for fiscal spending. An increase or change in the eligibility of corporate bond purchases is possible.
- Finally, Thursday’s meeting has the potential to feature the most open calls for fiscal easing of any central bank in recent history. Mario Draghi’s final press conference last year already featured tacit acknowledgement that monetary policy had limited capacity to lift growth in the eurozone. Calls for fiscal policy to “do its part” have long featured in ECB communication. Lagarde could take these calls a step further by openly acknowledging the ECB may not be able to fully offset the incoming shock to growth, and call for fiscal measures to do so.