European Central Bank leans into active inertia

Having been upstaged again last week by the Federal Reserve, the European Central Bank will join its US counterpart in global economic spotlight when the Governing Council meets on Thur- sday in Frankfurt and, like Fed, signals further monetary stimulus ahead. But ECB is facing a much more difficult script than the Fed. Lacking a more substantial role, the council’s performance likely will be driven by “active inertia,” appearing to be active and responsive but ending up simply repeating what it has done on many prior occasions: that is, more of the same despite growing evidence of its limited impact.
Let’s start with the reasons the ECB’s task is so much trickier than that of the Fed (which doesn’t have an easy task ahead of it, either).
The European economy has been slowing for the last year, led by perennial powerhouse Germany, whose economy is facing a widening gap between more buoyant domestic activities — construction and other non-tradables — and sectors hit by lower global demand. This all comes at a time when investment and consumption in Europe are less sensitive to liquidity stimulus, especially with financial conditions being so loose.
Policy interest rates are already negative, raising concerns about unfavourable implications: promoting ineff- icient financial intermediation, distorting asset allocation, weakening more banks, and creating a less hospitable environment for consumers’ long-term financial-protection pro- ducts such as life insurance and retirement.
The stock of bonds eligible for purchase by the ECB has been diminishing, causing headaches not just for the central bank but also for others — institutions and markets — that are being affected by a shortage of risk-free assets.
Simply expanding the ECB’s universe of allowable instruments is far from simple, and not just for economic reasons. It also entails increasing political risks.
The scope for moral hazard increases as additional ECB stimulus takes pressure off other policy-making entities in Europe while encouraging market participants to take on even more risk.
Further loosening of monetary policy increases the risk that Europe will be seen as aiming for an unfair currency-competitive position in order to maintain what already is a notable current-account surplus, thereby increasing the probability of US tariffs.
Finally, the ECB is on the verge of a transition of leadership to the International Monetary Fund’s Christine Lagarde, who is due to replace Mario Draghi in October; it’s one of several changes in the Governing Council.
—Bloomberg

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO.