ECB's Big Bazooka Is Losing Ammunition as Economy Teeters

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06/07/2019 | 12:33 pm


By Brian Blackstone and Tom Fairless



The European Central Bank has pushed interest rates into negative territory and bought trillions of euros in bonds to sustain the eurozone's economy. Now, with the economic expansion flagging, a critical question is emerging: How much does it have left in the tank?



Not much, analysts say, unless the ECB gets more creative on interest rates and asset purchases.



ECB President Mario Draghi signaled Thursday that the ECB is considering rate cuts and restarting bond purchases, as central banks around the world weigh easier monetary policy.



Mr. Draghi's verbal signals -- even though the ECB took no fresh action on rates -- are one tool commonly used by central bankers: communication with financial markets that can ease financial conditions without doing anything. Other ECB stimulus has included rate cuts, bond purchases and cheap long-term loans to banks, called TLTROs. The terms of those loans could be sweetened more to encourage lending, analysts say.



Yet the ECB is constrained in how forcefully it can deploy this traditional tool kit, a view underscored by the limited reaction in European markets to Mr. Draghi's comments. The euro rose, even though easier monetary policy usually weakens a currency. Germany's 10-year bond yield fell to a record low but other European bonds were mixed. Bank stocks fell.



The ECB's key policy rate is already negative and further cuts could weaken European banks by forcing them to pay higher fees to park excess reserves. Roughly EUR2.6 trillion ($2.9 trillion) in government and private-sector bond purchases from 2015 through 2018 left the ECB's balance sheet very high at about 40% of eurozone GDP, limiting the scope for more large-scale purchases.



Acting incrementally on these fronts "would not be our famous big bazooka, but would show that they are able to do something," said Carsten Brzeski, an economist at ING Bank.



If the world economy is indeed on the cusp of a fresh easing cycle -- central banks in the Asia-Pacific region have already lowered rates and the Federal Reserve has signaled it may do so too -- then the ECB is starting in a weaker position. The Fed's policy rate is positive, at a range of 2.25% to 2.5%, giving it more room. The U.S. has a deeper pool of government bonds, giving the Fed plenty of assets to buy if it wishes.



Bolder steps by the ECB, Mr. Brzeski said, would require tweaking existing rules to make it easier to purchase more government bonds or corporate debt, which is a small share of the total. But financing costs are already super low, and reducing them more could keep inefficient, profitless firms afloat -- weighing on productivity -- or fuel housing bubbles in places like Germany.



The ECB has "considerable headroom" to buy assets again, Mr. Draghi said Thursday.



An extreme move, Mr. Brzeski said, would be to expand the pool of available assets to include European equities. Japan's central bank already buys equities. Switzerland's does too, though the Swiss National Bank only holds foreign equities to weaken the strong Swiss franc and protect exporters.



The impact of equity purchases would be limited, however, because eurozone households tend not to own much in stocks.



Another step that Japan has used, explicitly targeting long-term yields, would be hard to replicate in Europe because the euro bloc has 19 different government bond markets.



Still, the need to quickly follow Mr. Draghi's words with actions was underscored Friday by grim economic reports from Germany. Industrial production plunged 1.9% in April from March. Exports fell by 3.7% in April. Germany's central bank warned Friday of a "marked cool down" in activity and shaved its forecast for gross domestic product growth this year to 0.6% from 1.6%.



The ECB refrained from taking fresh easing steps Thursday, though it did extend the time frame for any future rate increases to the middle of next year. In a press conference, Mr. Draghi said "several" members of the ECB's 25-person governing council discussed a reduction in the bank's minus 0.4% deposit rate while others raised the possibility of restarting asset purchases, which ended last December.



Central banks' money-printing powers mean they never truly run out of options. Buying assets with freshly-created reserves reduce long-term interest rates by raising the supply of money. That, in turn, makes it easier for households and businesses to borrow and spend.



But in the ECB's case, its existing tool kit quickly runs into limits or negative consequences.



Some officials -- notably Bundesbank President Jens Weidmann, a possible successor to Mr. Draghi later this year -- are skeptical of government bond purchases, which are controversial in Germany due to concerns about central banks financing governments. The ECB is also approaching self-imposed limits that restrict how much of an individual government's debt the central bank can buy. Those limits could be raised, but that could pose legal risks.



Lowering the deposit rate further could help by weakening the euro and strengthening exports. The ECB could offset some of the damage to banks by introducing exemptions that would allow them to pay a lower fee up to a certain amount of reserves.



"No policy option is straightforward," said Nick Kounis, an economist with ABN Amro. "It's a balancing act."



Write to Brian Blackstone at brian.blackstone@wsj.com and Tom Fairless at tom.fairless@wsj.com





 


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