The European Central Bank (ECB) should increase its use of “unconventional” policies to aid the continent’s economic recovery, according to the managing director of the International Monetary Fund.
In one of the most explicit calls yet for monetary stimulus in the eurozone, Christine Lagarde referred to the risk of “low-flation” to the eurozone’s economy which is only just emerging from a prolonged period of recession.
The ECB meets later today to decide whether to maintain its interest rate at the record low level of 0.25 per cent.
“A potentially prolonged period of low inflation can suppress demand and output, and suppress growth and jobs,” Ms Lagarde said in a speech in Washington yesterday.
“More monetary easing, including through unconventional measures, is needed in the euro area to raise the prospects of achieving the ECB’s price stability objective.”
Ms Largarde acknowledged that a “modest recovery” was taking hold in the eurozone, and praised the “encouraging steps” taken to establish a banking union across the currency bloc.
“Implementing a common fiscal backstop remains key, as is the upcoming asset quality review of banks,” she added.
The ECB has been reticent to pump money into its financial system in the same way that the US and UK central banks have, through buying billions of dollars worth of government bonds to encourage money to be spent elsewhere in the financial system. Instead it has chosen to cut its central interest rate from 1 per cent at the end of 2011 down to 0.25 per cent from November 2013.
Azad Zangana, European economist at Schroders, agreed that low inflation was “a serious risk” to the continent.
“Low inflation in the eurozone is becoming a serious risk that could lead to outright deflation,” he said.
“While our central view is that Europe will not experience a Japanese-style episode [of prolonged deflation] as recovery continues, we cannot ignore the warning signs that the risk of deflation is escalating.
“Deflation or even prolonged very low inflation could cause many governments’ balance sheets to become unsustainable. The tail risk is growing, but is the ECB paying attention?”
Pimco’s Andrew Bosomworth, managing director and head of portfolio management in Germany, said he expected the ECB not to make any changes at today’s meeting but forecast that policy may be loosened “within the next three to six months”.
He cited a rate cut to 0.15 or 0.1 per cent as a possibility, as well as preferential treatment for banks lending to small businesses, but played down the likelihood of imminent quantitative easing (QE) in the eurozone.
“QE would lower yields in all countries but probably have disproportionally large larger impact in countries like Italy and Spain, hopefully boosting their investment and consumption,” Mr Bosomworth said. “But lower interest rates in Germany might risk a real estate bubble developing there, where signs of speculation are already emerging.
“So while QE may achieve a higher overall eurozone inflation outcome, it is not clear whether the composition of that higher inflation would be any healthier than the composition of today’s low inflation.”
