ECB must take stimulus steps warily

The European Central Bank’s (ECB) expected move to announce new bold stimulus measures aim to reverse negative economic outlook in eurozone, even as some banking circles doubt such a step could help. The measures may include a further cut in interest rates, an increase in the volume of bonds it buys each month under its so-called quantitative easing or QE programme and a further extension of that measure beyond its current timeframe of March 2017.
Concerns that depressed commodity prices may raise the risk of deflation, as well as a string of data from China that reflect extent of emerging market slowdown, worry the ECB. Indeed, the low growth in China and Brazil is weighing on global demand and sending deflationary waves around the world through sharply lower oil and metals prices.
ECB head Mario Draghi said, “The situation was amplified by perceptions that banks may have difficulty in adjusting to an economy with lower growth and lower interest.”
Yet, the ECB plan to announce stimulus measures is opposed by some banking circles who believe the current measures should be given enough time to work. A number of governing council members, notably Bundesbank chief Jens Weidmann, are opposed to additional stimulus measures.
The minutes from the December meeting, published in January, revealed that “some members” believed that “the existing policy measures were working in the right direction and more time should be given for them to unfold their full effect before adopting further monetary policy measures”.
But each option comes with side effects and limited functionality as monetary policy is deep in unconventional territory, making decisions less likely given the difficulty of aligning the interest of 19 countries and 25 policymakers.
“Negative Interest Rate Policy (NIRP) seems to be all the rage in central bank circles these days,” Morgan Stanley said in a note to clients, arguing that such policies do not actually help bank lending.
Unlike Europe, the economic outlook for the United States is brighter, with Friday’s non-farm payrolls figures easing fears that the world’s largest economy was heading into recession and potentially allowing the Federal Reserve to gradually raise interest rate this year.
However, China’s faltering outlook will remain a top concern for policymakers around the globe and investor focus will be fixed on the annual meeting of China’s parliament, which must try to engineer a huge economic shift towards services and consumption and away from basic manufacturing.
Banks worldwide are facing a host of factors, notably falling crude oil prices are hurting the business of energy companies, which in turn affect their ability to repay loans. But American banks have shored up capital reserves better than their European counterparts to offset loan losses, according to CNBC. Meanwhile, low or negative interest rates are squeezing profits at a time when European banks still have plenty of debt.
Low economic growth in Europe saps the banks even as their capital positions have strengthened. Yet, the bank balance sheets are still burdened by troublesome loans. According to a February 23 report by the European Banking Authority, the quality of banks’ loan portfolios improved but “remains a concern” while profits are “still low”. The yield curve — a proxy for bank profitability — is the flattest it has been in years, a signal that margins are squeezed.
Though the financial institutions are stronger in Europe compared to 2008, eight years after the crisis, Europe has not yet fully recovered as it passes in a transitional phase.
Therefore, euro area needs higher growth spurred by financial institutions and policymakers who are capable of outlining a stable regulatory environment to make financial system safer. As they had in the past weathered the storm during financial crisis, they are capable to address new challenges, among others, the UK referendum, and looming global economic slowdown. And ECB’s plan to cut interest rate is timely to stave off the risk of economic slump, and stimulate the economy in the eurozone.