European Central Bank to decide if €1 trillion stimulus is enough

President Christine Lagarde is likely to reiterate her pledge to do everything necessary to support euro area economies

The European Central Bank (ECB) headquarters stands in Frankfurt, Germany, on Wednesday, April 29, 2020. The ECB's response to the coronavirus has calmed markets while setting it on a path that could test its commitment to the mission to keep prices stable. Photographer: Alex Kraus/Bloomberg
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The European Central Bank will decide on Thursday if more than €1 trillion ($1.1tn/Dh4tn) in asset purchases and a generous lending plan are enough to keep companies and households afloat during an historic slump.

Most economists predict the Governing Council will pause after a series of actions to support the economy since its last official meeting to see whether governments can agree on comprehensive fiscal support. A minority including Goldman Sachs though expect a bump up in monetary stimulus immediately.

President Christine Lagarde is likely to reiterate her pledge to do everything necessary as most of the 19-nation euro members face more severe recessions this year than during the global financial crisis. Investors will be listening carefully, after a verbal slip-up in March sent bond markets tumbling.

The ECB will announce its decision at 3.45pm UAE time, and Ms Lagarde’s virtual briefing begins 45 minutes later.

With policymakers showing little appetite for further interest-rate cuts – the deposit rate is already at -0.5 per cent – economists polled by Bloomberg expect the ECB to boost its €750 billion pandemic bond-buying plan by another €500bn at the September meeting. That would take this year’s tally across all programs above €1.5tn.

But size isn’t the only option to make the plan more powerful. Citigroup’s Arnaud Mares, a former adviser to Ms Lagarde’s predecessor Mario Draghi, has suggested policymakers could ditch a rule on how purchases are distributed across the bloc, a move that would allow them to respond more flexibly to market shifts.

Another question is whether junk-rated debt will become eligible for buying, after the ECB said it would temporarily accept some of it as collateral.

Even though updated economic projections would not be available for another five weeks, Ms Lagarde will be quizzed about the ECB’s latest view. Last week, she told European leaders euro-area output could drop by as much as 15 per cent this year.

Just before taking their decision, policymakers will receive an initial estimate for the first quarter. A Bloomberg survey points to a 3.7 per cent contraction, with forecasts for the current period suggesting an even steeper slump.

Much will depend on how quickly governments will ease restrictions. Bloomberg Economics expects the economy to shrink 8.1 per cent in 2020, with risks skewed to the downside.

Investors have zoomed in on Italy, the European epicenter of the pandemic, where government debt could climb above 160 per cent of output this year.

The country was dealt a blow on Tuesday when Fitch surprisingly downgraded its credit rating to one level above junk, citing debt-sustainability concerns. Separately, S&P Global Ratings affirmed its assessment.

So far, bond purchases by the central bank and a more conciliatory approach by Prime Minister Giuseppe Conte to EU efforts have prevented bigger spikes in yields. Yet the situation could deteriorate quickly if financial market see stimulus measures falling short.

The ECB’s actions – both on the monetary-policy and the supervisory fronts – are focused on ensuring bank lending would not dry up. Loan growth to companies surged in March as businesses rushed to ensure they can pay rents and wages during the lockdown.

After the ECB allowed banks to temporarily use financial cushions built up after the last financial crisis, they got another lifeline from the European Commission on Tuesday, which proposed a series of tweaks to further ease the burden.

With many of their borrowers in trouble, lenders are still expecting major losses in the wake of the pandemic. Economists at Banque Pictet encouraged officials to consider cutting the interest rate on long-term loans. It’s already below the ECB’s deposit rate, meaning banks are effectively paid by the central bank to extend credit.

The ECB has not received much support from politicians in the form of a joint response. While large in scale, national fiscal stimulus has varied widely across the euro area, raising concerns that the recovery – once it arrives – will be uneven.

“A rebound is likely in 3Q, reflecting ample fiscal support in some countries and a return to work for many workers in the more flexible segments of the labor force,” according to Bloomberg economists.

The EU leadership has only agreed on a rough outline for a reconstruction plan, leaving unresolved the key issue whether it should be based on grants or loans to member states. There is also concern they are relying too much on leveraging their own contributions with private investments.

The press conference gives Ms Lagarde an opportunity to send another message to wavering politicians, after she warned them last week that they risk doing too little, too late.