October 1, 2013, 5:07 PM ET
What to Expect From ECB Meeting
By Brian Blackstone
The venue for Wednesday’s European Central Bank meeting may be different (it’s in Paris this time instead of at Frankfurt HQ), but the economic and financial backdrop that officials face is largely the same as it was in the summer: a so-so recovery with weak lending and very low inflation.
The euro bloc’s economy has shown signs of stabilizing after a lengthy recession, even in the region’s trouble spots such as Spain. Short term money market rates have stayed largely in line with the ECB’s forward guidance, namely that the central bank will keep official rates low, or lower, for an “extended period.”
Unemployment fell slightly across the euro zone in August, though at 12% the jobless rate remains near euro-era highs. Purchasing manager surveys point to a second-straight quarter of economic growth, albeit at a weak pace.
In short, things could be better in Europe, particularly for the economy and credit conditions. But they could be a lot worse, too, given the severity of the debt crisis that engulfed Greece nearly four years ago and rippled through southern Europe and Ireland.
But there are some trouble spots that could disrupt the relative calm in financial markets and put renewed pressure on the ECB to do more.
Politics. Italy’s five-month-old government confronts a key test Wednesday when Prime Minister Enrico Letta faces a confidence vote that could bring down the fragile governing coalition.
Renewed political uncertainty could at some point drive Italy’s borrowing costs higher and put the ECB’s bond purchase program–which has yet to be used–into play. But without a stable government, Italy would have trouble agreeing to additional deficit cuts and economic reforms, which are a condition to the ECB’s Outright Monetary Transactions program being used.
As Nicholas Spiro, head of Spiro Sovereign Strategy notes: “Italy is in no fit state to apply for, and make use of, the OMT. This throws the weaknesses and limitations of the OMT program into sharp relief.”
Economics. The euro zone exited a lengthy recession during the second quarter with annualized GDP growth of 1.2%. Business surveys point to modest growth in the third quarter, too. But hard data on industrial production and consumer spending suggest the third quarter started on very weak footing. The bloc may struggle to post annualized growth much above 0.5%. And the recent rise in the value of the euro could hit exports in coming months.
Lending. It’s still declining. Loans to the private sector fell 2% in August from a year earlier, a more pronounced slide than in July. The ECB has tools to address this. It could reduce official interest rates or pump more cheap, long-term loans into banks. ECB President Mario Draghi last week cited new loans, known as long-term refinancing operations, as an option if money market rates were to rise too much. But some analysts question whether they would do much good given the need for banks in southern Europe to shrink their balance sheets in a weak economic environment.
Inflation. In the end, this is the ECB’s primary mandate, to keep annual inflation just under 2% over the medium term. Annual inflation was 1.1% last month, the lowest in three years. And the ECB expects it to average 1.3% next year, still well below its target.
The mix of weak growth, declining private-sector lending and low inflation should keep another interest rate reduction in play, even if officials don’t deliver on Wednesday. At a minimum, the economic and inflation backdrop gives the ECB ample scope to maintain its pledge to keep policy ultra loose for an extended period.
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