Despite the relatively optimistic forecasts from economists for the global economy going forward the Eurozone continues to face potentially very serious risks. It is against that backdrop that the European Central Bank's (ECB) Governing Council will meet to decide its next course of action. Ahead of such an important event for markets Sharecast has canvassed a group of leading economists and analysts on their views ahead of that event:
Q: The Bank of England's Funding for Lending Scheme (FLS) has not reactivated bank lending to businesses nor small-and-medium-sized enterprises (SMEs) in the UK, in particular, as banks are not liquidity constrained but rather capital constrained, due to the uncertainty over yet to be decided changes to their capital requirements. Something for the ECB to keep in mind?
I don't think the Bank of England (BoE) was under any illusions the Funding for Lending Scheme would really help; the programme was a political move given the immense pressure the BoE was under to act. It is the same with the ECB; any similar FLS will be more important for it's ignoring that the ECB is willing to act rather than for its actual impact on lending. - Megan Greene, Director of European Economics at Maverick Intelligence
Although the situation is similar, lenders may have a higher incentive to use the liquidity injected by the ECB to give out new loans. In our opinion the key is that the ECB act to minimise the risks of economic stagnation and persistently low inflation. That is the key for banks to perceive less default-risk. Nonetheless, in the short term, we do not anticipate a huge impact on volumes of new lending, given the regulatory context which we expect for the next few months (AQR and stress test). - Emilio Ontiveros, President at AFI, the highly respected Spanish economics house.
Capital constraints to one side; there needs to be a demand for loans if this is to succeed. The debt crisis and recession has dampened demand for loans, especially in southern Europe. Instead of increasing their lending to businesses, banks could respond by moving money from the ECB to non-Eurozone central banks, putting it in a vault, passing on the cost to their customers, or holding less cash on their balance sheets in an effort to meet capital requirements. - Brenda Kelly, Chief Market Strategist at IG.
I do not agree that the issue of non SME lending is either capital constrained. Banks know like everyone else does that the majority of SME's fail and in a low interest rate environment they can simply not make money out of them - before they go bust. [...] It should focus on helping the PIIGS nations as much as possible, which means weakening the euro as much as possible. The issue is that it may be too little, too late. - Zak Mir, Editor Spreadbet Magazine
Q: Some analysts fret that further ECB easing has already been discounted by financial markets. Do you agree? How might Mario Draghi go about compensating for this?
I agree that most of what the ECB is considering is already priced into the markets. The only thing Draghi can do to combat this is to announce something with real shock and awe value, but this is hugely unlikely. - Megan Greene
We believe that the expected conventional measures (reduction of the repo rate and the rate on the Deposit Facility) have been broadly discounted already, at least by those instruments which are the most sensitive to short-term expectations, such as EONIA. But any delay in expectations for quantitative easing (QE) risks a rebound in risk premia. The euro's strength also factors very heavily into the ECB's reaction function nowadays. - Emilio Ontiveros
I think all the build-up talk of Draghi and Co has prepped us for something (EUR/USD well back from 1.40), but I think comments have also been varied enough (carefully orchestrated) so that the ultimate move isn't a given. Will we get a rate cut? A negative deposit rate? Another LTRO? Would Draghi dare say inflation should bounce next month and we'll wait until then? We've been there before. Lastly, will a rate cut or more cheap money even make a difference to the real economy? - Mike van Dulken, Head of Research at Accendo Markets
If anything, given the short squeeze currently seen in the euro crosses, nothing short of full scale QE will be sufficient to see the single currency move lower for any significant period. The curve in EONIA also shows that investors have discounted the move (rate cuts). We must never forget that the Fed is on the other side of the cross and the old adage of not fighting the Fed coupled with the possibility that any actions could attract more Eurozone investment flows may work against the aims of the ECB - Brenda Kelly
The ECB easing has been discounted by the financial markets, which is just as well otherwise Euro/ Dollar would be threatening $1.40 plus again. Mario Draghi should compensate for this by doing what he does best, making promises that may or may not have any real substance (whatever it takes to save the Euro), but which traders have to go along with anyway - just in case he acts. - Zak Mir
Q: Will the ECB be forced to undertake full-blown quantitative easing at some point down the line? If so, when?
The ECB may be forced to buy private or public assets in order to avoid a deflationary spiral if medium-term inflation expectations adjust downwards. That being said, most policymakers seem to think the crisis in the Eurozone is over so the ECB will be reticent to bring out the big guns as the region seems to be recovering when it refused to do so in the heart of the storm. - Megan Greene
In its last Financial Stability report the central bank highlighted the risk of an abrupt reversal in yields as the main risk for stability in the single currency area. In our opinion, the bulk of the narrowing in sovereign risk is explained by the predisposition of the ECB to act to reduce financial fragmentation and deflation risks. So we believe it is necessary that any type of QE programme - focused on private debt purchases and/or a conditional LTRO - be introduced before the summer. - Emilio Ontiveros
QE will only come if the Eurozone economy and inflation develop significantly worse than we expect. It is certainly not an option in the near term ahead of the bank stress tests. The ECB will not be willing to use up the entirety of a potential arsenal - there is still no guarantee that they will get the support or the mandate to do it. Even in the case of the US one could question the long-term sustainability of such an approach. - Brenda Kelly
As I implied in answer 1. my view is that the ECB's position on the deflation cycle could be manyyears behind where Japan is now, something which implies full blown QE, a bubble in selected assets and then another bubble burst such as 2007 - 8. - Zak Mir
Q: Is the onus now on the ECB to act or is there is still a need for governments in Spain and Italy to undertake further structural economic reforms? Are they politically feasible at this point?
The onus is on the ECB to act in the first instance to carry out it's mandate of price stability. However, the ECB cannot solve the imbalances in the EZ--that is up to nation-states, which must implement structural reforms in order to find sustainable growth. - Megan Greene
The European elections and the restraint shown by some governments in moving forward with the process of fiscal consolidation and structural reforms constitute relevant restrictions for the adoption of QE measures by the ECB. Therefore, it is unlikely that the ECB will decide to buy government debt, opting instead for a conditional LTRO and/or a credit facility for asset-backed securities using new SME loans as collateral. - Emilio Ontiveros
The onus is of course on the ECB to act after all this time and with the region's CPI so low this morning, confirming the real treat of deflation, but Spanish Italian AND don't forget French governments must stay the course in enacting the tough, and in many cases painful, reforms required to get their deficits under control and their and economies back on track. Ireland is a case in point: no pain, no gain. - Mike van Dulken
The political upheavals in the individual countries and indeed the backlash currently being witnessed against anything EU is problematic. High unemployment levels, especially amongst the youth are a significant issue. Governments need to drive growth and investment. Unfortunately and ironically it could be said that Draghi removed the impetus to drive reforms with his "everything it takes" speech in July 2012. Is the political will even there? - Brenda Kelly
I am afraid to say that the only feasible political reform that either Spain or Italy should be taking in this respect is to leave the Euro. But unfortunately to do so would be such an admission of failure both in the EU experiment and its resultant 25% unemployment rates currently, that such a U-turn is not likely to happen for a long time. - Zak Mir