The ECB is under pressure to follow other central banks and undertake measures to support the economy during the coronavirus crisis but it has little room to lower interest rates (Daniel ROLAND)

Frankfurt am Main (AFP) – The European Central Bank is under pressure Thursday to show it too has the firepower to respond to the coronavirus crisis and shore up the eurozone economy after other major central banks have already leapt into the breach.

With markets plunging, companies’ cashflow drying up and financial stability under threat from the COVID-19 disease this means it is ECB president Christine Lagarde’s “big test”, said Pictet Wealth Management strategist Frederik Ducrozet.

“Markets need a circuit-breaker, whatever works,” he added. 

The pressure to act in the eurozone is all the greater this week following big moves from the Bank of England and US Federal Reserve, which both slashed key interest rates in extraordinary meetings.

In a conference call Tuesday with European heads of government, former International Monetary Fund (IMF) head Lagarde “drew comparisons with past crises” like the 2008 financial crisis, a European source told AFP.

Lagarde was “measured… speaking of an ‘impact’, but not a collapse,” the source added, although the effects for the economy remain “very difficult to predict”.

Unlike the 2008-9 financial crisis, central banks face an environment where international cooperation is not the first reflex of leaders like US President Donald Trump or British Prime Minister Boris Johnson.

Now, “everyone is acting in their little corner of the world, often by surprise, and causing pressure or difficulties for the others” by shifting exchange rates, said Eric Dor of France’s IESEG management school.

– Markets on edge –

Markets worldwide plunged Monday as an oil price war launched by Saudi Arabia melded with virus fears.

As traders remain jittery, eurozone inflation expectations on Tuesday touched all-time lows — calling further into question the ECB’s ability to stoke price growth to its just-below-two-percent goal after years of stimulus.

The Fed last week and BoE on Tuesday had space to cut interest rates by half a percentage point each to ease financial conditions.

By contrast, key ECB rates are already at historic lows, with the rate on banks’ deposits in Frankfurt at -0.5 percent — meaning the central bank is effectively charging lenders to park money with the central bank.

Policymakers are unlikely to cut more than 0.1 or 0.2 percentage points further into negative territory, economists judge.

Instead of the classic central bank lever of interest rates, the ECB has other tools to turn to.

It could add to its portfolio of cheap loans to banks, known as TLTROs, which offer more favourable conditions for lenders the more credit they pass on to the real economy.

A source close to the ECB told AFP a “TLTRO targeted at small- and medium-sized firms” could be on the table, as those companies are believed to be especially vulnerable to the coronavirus fallout.

And there theoretically remains room to increase its “quantitative easing” (QE) programme from its present 20 billion euros ($22.6 billion) per month pace.

But the bond-buying scheme is deeply controversial.

– Governments on hook –

The total of over 2.7 trillion euros of QE asset purchases so far have brought the ECB under unprecedented political and legal attacks and sowed deep divisions within its governing council.

Much of Lagarde’s work since taking office in November has been to salve such wounds.

Her press conference on Thursday will likely include an appeal to governments to intervene with tax and spending changes.

In mid-February, she reiterated that “monetary policy cannot, and should not, be the only game in town” to stimulate the economy.

Italy on Wednesday announced 25 billion euros of support to its economy and the European Union has also mobilised up to 25 billion euros.

Chancellor Angela Merkel even signalled Wednesday that Germany could abandon its balanced-budget dogma.

“It is an extraordinary situation, we will do what’s necessary… and we will see at the end of that where our budget stands,” Merkel said.

Policymakers “cannot offset the direct hit from the virus epidemic to supply and demand,” noted Berenberg bank analyst Florian Hense.

But the central bank — alongside government tax and spending changes — “can help to contain second-round effects on liquidity and confidence, and help to arrest a market rout,” Hense added.

Disclaimer: Validity of the above story is for 7 Days from original date of publishing. Source: AFP.