Economics: ECB frets over euro strength, trade war risks

European Central Bank policymakers gathering last month expressed concern over the risk of a full-fledged trade war with the United States and fretted over the potentially harmful impact of the euro’s strength, the minutes of the meeting, released yesterday, showed.

With the Eurozone economy growing for five straight years, policymakers are now debating how to wean the bloc off easy money and prepare investors for normalising policy a decade after the global financial crisis sent central banks into crisis mode.

The ECB has so far moved by increments to dial back support. In March, it gave up a largely outdated pledge to raise asset buys if needed, a symbolic move that kept it on course to end its €2.55 trillion asset purchase programme by the end of this year.

While the euro’s firming in recent months, partly due to fears over US protectionism, has not significantly curtailed demand, policymakers called the exchange rate a “significant source” of uncertainty with some predicting a more negative impact on inflation.

Investors have been wondering whether the European Central Bank’s carefully calibrated exit plan from its ultra-easy policy could be scuppered by a looming trade war between the United States and China although ECB policymakers have so far played down this risk.

Launched three years ago, the ECB’s bond buys depressed borrowing costs, kick-started growth and helped fight off the threat of deflation. But inflation, the ECB’s singular mandate, has remained weak and will undershoot the bank’s target of just under 2% for years to come, a threat to the bank’s credibility.

Still, policymakers argue that with spare capacity largely exhausted in the bloc and growth motoring ahead, it is only a matter of time before inflation picks up, so the ECB can afford to dial back its stimulus and give price growth time to accelerate.

A view was put forward arguing that the ECB was close to meeting its criteria for a sustained adjustment in the path of inflation, but there was broad agreement that progress is not yet sufficient. Still, policymakers were in agreement that their confidence has increased that inflation would gradually rise back towards target.

Once bond buys end, investor focus will turn to interest rates as the ECB has said they would stay unchanged “well past” the time the QE programme concludes, an ill-defined timeline that is seen by markets as roughly six months.

Alan McQuaid (13/4/18)
Economist