ECB’s greatest risk is the danger of doing nothing

The eurozone needs be given further monetary stimulus this week
 
 
 
Ahead of the European Central Bank’s governing council meeting later this week, the single currency’s bankers are buffeted by even stronger pressures than usual — from all sides. They should heed those calling for stronger action over those advocating restraint.
 
The case for more forceful monetary stimulus builds on the many deflationary signals that have accumulated since the start of the year: market turmoil; unexpectedly sharp disappointments in current and forecast inflation; and a global slowdown where US weakness has put the brakes on what last year looked like a promising acceleration in Europe.

On the other side are warnings that the ECB may achieve the opposite of what it wishes if it goes deeper into uncharted monetary territory. Many think the asset purchase programme launched in January 2015 is buying ever less stimulus bang for each quantitative easing buck.

Others warn that a lopsided use of monetary policy stimulus is tantamount to engaging in a currency war, surreptitiously targeting a lower exchange rate to steal demand from other countries.

The fiercest resistance has been reserved for negative interest rates, a policy now used to a lesser or greater extent by central banks covering a quarter of the world economy, including most of Europe.
 
One pushback comes courtesy of the Bank of International Settlements. In research released just days ahead of the ECB decision, the so-called central bankers’ central bank has suggested that interest rate cuts may no longer stimulate the real economy once they cross zero. The BIS fears banks will not pass on lower central bank rates to borrowers, and perversely will tighten their lending as their profitability suffers.
 
Meanwhile, some banks are reportedly planning to hoard physical cash to circumvent the ECB’s negative rate on reserve deposits, thus blunting the transmission of the policy to households and businesses.

Many of the ECB top brass have pushed back against these naysayers, laying the ground for loosening eurozone monetary policy further this Thursday. They should not now get cold feet; nor should the rest of the governing council weaken them with merely lukewarm support (or worse).
 
Markets are pricing in a further cut in the deposit rate, and analysts foresee expanded asset purchases and new long-term loans to banks. The ECB should not now disappoint their expectations. Not because it is a central bank’s job to please the markets, but because the fall in market rates prove that the market policy transmission is alive and well. More aggressive loosening will ultimately force banks to follow where markets have already gone.
 
The euro’s central bankers need not fear accusations of warmongering. There is no evidence that the eurozone has stolen demand from anyone: its external balance has barely budged since the end of 2014. Instead, the expectation of QE coincided with the end of the eurozone’s credit crunch two years ago, and its implementation with the pick-up in lending growth in 2015. If growth and inflation are not responding as much as one would like, the conclusion should be to do more of the same, not less.

In his most pointed refutation of his critics, Mr Draghi said in a speech early this year that “they warn us about the side-effects and risks of what we’re doing. But what I never hear them discuss is the risks of doing nothing.”
 
Not only are the risks of inaction greater than the risks of action, but that balance has also continued to tilt in favour of doing more.

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