LDN - Business

Exclusive: ECB to discuss closing door to extra stimulus next week - sources

[May 30, 2017] By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) - European Central Bank policymakers are set to take a more benign view of the economy when they meet on June 8 and will even discuss dropping some of their pledges to ramp up stimulus if needed, four sources with direct knowledge of the discussions told Reuters.

With economic growth clearly shifting into higher gear, rate setters are ready to acknowledge the improvement by dropping a long-standing reference to downside risks in the bank's post-meeting opening statement, calling risks largely balanced, the sources said. Growth indicators have been outperforming expectations all year.

But they disagree on how quickly the ECB should change its policy stance, including its guidance, with countries on the currency bloc's periphery fearing that a sharp shift in its communication could induce self-defeating market turbulence, they added.

"After the French election the political risk is clearly down and economic indicators are by and large positive, so it's time to acknowledge this," said one Governing Council member who declined to be named.

Having fought off the threat of deflation with years of extraordinary stimulus, the debate within the ECB is shifting to the pace of normalization, pitting doves who want incremental changes against conservatives who fear that the ECB could miss its cue, forcing more abrupt moves later.

"The positive environment has been relatively short compared to the long periods of crises we had," another source said. "It wouldn't be responsible to base a major policy shift on such a short upswing."

A key debate at the June 8 meeting is likely to be whether the bank should ax all or part of its so-called easing bias, a pledge keep rates at their current or lower levels for an extended period and to increase the volume of asset buys if the outlook worsens.

Though many investors expect a decision on this, the sources said that this was far from certain.

"This will be the first time we discuss this so I don't necessarily expect a decision," another source said.

Indeed, ECB chief Mario Draghi signaled caution on Tuesday, arguing that due to weak underlying inflation, he was firmly convinced that an "extraordinary amount" of monetary policy support is still needed.

Inflation figures due on Wednesday are expected to show a dip in both headline and underlying price growth, potentially easing pressure on the ECB.

[to top of second column]

The headquarters of the European Central Bank (ECB) (R) is seen next to the famous skyline in Frankfurt, Germany, April 9, 2017. REUTERS/Kai Pfaffenbach

The ECB declined to comment.

Though ECB decisions require a simple majority, votes are not always taken and decisions normally enjoy a full or near consensus.

GRADUALISM

The split among policymakers has become evident even within the six-member Executive Board, putting top allies of Draghi in different camps.

Chief Economist Peter Praet has warned that even incremental changes in communication could send strong signals, while Vice President Vitor Constancio argued that it is better for the ECB to be late rather than early in removing stimulus.

But board member Benoit Coeure has noted that too much gradualism bears the risk of a larger market correction down the road, highlighting the risk of market expectations becoming detached from the bank's guidance.

"Everybody knows we won't cut rates, so formally acknowledging that should cause no ripples," one of the sources said. "There is a credibility problem when your signals are very different than what the market expects. We're not yet there but it's a risk."

Removing the reference to further rate cuts could risk strengthening the euro, a problem as the currency has already gained more than 5 percent since mid-April against the dollar.

While the ECB does not have an exchange rate target, a continued rise would hurt exporters on the periphery and dampen inflation expectations.

But removing the reference to higher asset buys could push yields higher, a worry as the ECB has already highlighted growing debt sustainability concerns. The ECB is also facing political uncertainty in Italy, one of its weaker member, which might not abate until elections are held later this year or early next year.

(Reporting by Balazs Koranyi; Editing by Hugh Lawson)

Back to top