Facing the growing risk of a deflationary spiral that could topple the 19-country eurozone into recession, the European Central Bank looks set to cut its deposit rate deeper into negative territory when it meets in Frankfurt on Thursday.
The bigger question is whether the central bank will pull out the big guns and expand its existing quantitative easing program, since monetary policy is now nearing its limits and already is in unconventional territory.
“Since the ECB’s January meeting, the case for further stimulus appears to have increased,” Howard Archer, chief European economist at IHS Global Insight, said in a note Wednesday.
The ECB left interest rates unchanged at its last meeting in January, which came a month after policymakers dropped the interest rate on the bank's deposit facility by 10 basis points to negative 0.3 percent. This unconventional approach charges financial institutions for their deposits and lowers the price of borrowing for everything from corporate investments to credit card charges.
ECB President Mario Draghi hinted at further easing measures during a speech to the European Parliament last month in which he said the ECB would “not hesitate to act” to implement further stimulus measures. Another verbal commitment to take further action if necessary is likely Thursday.
Indeed, official data released last week show the eurozone fell back into deflation in February for the first time since September. This important indicator of the region’s path to economic recovery has slowed for 10 consecutive quarters, leading some to call for the ECB to lower its 2 percent annual inflation target.
To tackle this lingering problem, Draghi could announce an expansion of the quantitative easing program first implemented early last year. The ECB currently buys certain types of bonds from financial institutions to the tune of 60 billion euros ($66 billion) a month. The aim of the program is to channel money into the financial system to stimulate economic growth, and a perceived lack of traction in the program could mean more stimulus measures are coming.
Draghi could announce an increase of the monthly purchases, but the ECB is running out of eligible bonds. Some investors are betting that an expansion of the bond-buying program would also include a wider range of qualified assets, including corporate debt, according to the Wall Street Journal.
The ECB could also announce a change in the way financial institutions deposit money at the central bank, a common requirement in modern finance that’s designed to allow banks to borrow and lend with each other and keep cash in reserve to tackle financial meltdowns.
Negative borrowing rates are bad for banks because the institutions are hit with both a cost for making central-bank deposits and lower profits from lending money to companies and individuals. So if the ECB dives deeper into negative-rate territory, it could also announce a two-tier system that would give banks a higher rate for a portion of their deposits.