The ECB’s path forward: struggling to change the game

Key takeaways

• While easy monetary policy has supported growth in the euro area, and deflation fears have largely subsided, the adverse effects of negative interest rates on banks are hard to ignore
• The ECB has belatedly started to acknowledge this. Talk of a “tiered reserves” system has emerged, especially as the trade-driven economic slowdown has raised the possibility of rates staying low for (even) longer
• The effect would be a less punitive system for banks and an enhanced ability for policy easing for the ECB. But the magnitude of the impact on growth and inflation is likely to remain limited, while a prolonged period of negative rates is probably bad news for banks

ECB: Towards additional easing policies?

The recent economic slowdown, combined with the subdued level of core inflation and – crucially – the persistence of risks related to global trade tensions and Brexit, has pushed back the European Central Bank’s (ECB) normalisation plan and re-opened the discussion about available policy tools for further easing.

The ECB has already announced a new series of TLTROs (Targeted longer-term refinancing operations) starting from September 2019.

At this point, the eurozone’s monetary authority could also extend its forward guidance on interest rates further. Having previously renewed its commitment not to raise interest rates from “at least through the end of the summer” to “at least through the end of 2019”, the ECB is likely to push the time horizon out even further, given the current context.

But considering current market expectations, which suggest no rate increase between now and the end of 2020, and which price only about 10 basis points of hikes by late-2021 (see chart 1), it is unlikely that a forward guidance extension would have much impact.

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