ECB flags more stimulus ahead as financial conditions tighten

The European Central Bank has sent fresh signals that it is gearing up to inject more monetary stimulus into the eurozone’s flagging economy, as its chief economist cited “worrying signals” that financial conditions for banks and small businesses are tightening.

The minutes of last month’s rate-setting meeting, which were published on Thursday, painted a grim outlook for the eurozone economy, concluding it was likely to be “bumpier than previously projected” because of the need for coronavirus restrictions that were likely to continue next year.

“It could not be excluded that the euro area, or at least some countries, would experience a double-dip recession,” they warned.

The ECB governing council also discussed how the second wave of the pandemic could result in “more widespread business closures in a number of sectors, for example retail trade”, according to the minutes.

The minutes were published shortly after Philip Lane, chief economist at the ECB, warned that businesses’ demand for loans and the availability of credit were both contracting.

Speaking at Trinity College Dublin, he said he was worried about the possibility of “a mutually reinforcing adverse loop” if banks view falling loan demand as a negative indicator for the economy and companies draw the same conclusion as banks tighten their lending criteria.

He added there was a risk of “an unwarranted tightening of funding conditions” if governments delivered an insufficient fiscal response to the economic fallout from the pandemic.

The ECB said last month that it would “recalibrate” all its monetary instruments and announce the outcome at its next policy meeting on December 10, when analysts expect it to expand both its bond-buying programme and ultra-cheap loans to banks.

Investors interpreted the latest statements as strengthening the chances of a sizeable package of monetary easing measures. Sovereign bond yields fell in many countries, including a 2 basis point fall in Germany’s 10-year Bund yield to minus 0.59 per cent and a dip in Portugal’s 10-year bond yield into negative territory for the first time. Bond yields fall when their prices rise.

However, the minutes of last month’s ECB meeting also indicated that some council members were growing uneasy at the prospect of further monetary stimulus, expressing concern over “possible non-linearities, side effects and ‘diminishing returns’ in an environment of high uncertainty and very favourable financial conditions”.

“With markets having stabilised since the introduction of the pandemic-related monetary policy measures in March, it was noted that additional asset purchases might not have the same impact on financial conditions and real economic activity as they had earlier in the year,” the minutes said.

They also warned that ultra-loose monetary policy could lead to “the temptation for governments to enter into commitments that were difficult to undo and thereby increase expenditure beyond what was necessary to deal with the pandemic”.

Recent breakthroughs on developing coronavirus vaccines are causing some ECB policymakers to question how much monetary support the economy will need. 

“If you had asked me a few weeks ago, I would have said the outlook had gotten slightly worse than perhaps when we discussed it in September,” Gabriel Makhlouf, head of Ireland’s central bank and ECB council member, said on Thursday. “On the other hand, we will have to evaluate the emergence of the vaccine and what that might mean for activity and recovery.”

However, Mr Lane said that while the recent vaccine news was “very welcome and reduces the likelihood of the most severe scenarios”, he believed that “the current surge in infections and the reimposition of containment measures serve as warning signals that the recovery path will still be long and fraught with risks”.

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