The European Central Bank is almost certain to ease policy next week as depressed commodity prices raise the risk of deflation, while a string of data from China will offer clues about the extent of the recent emerging market slowdown.
Growth in most key economies has slowed this year as states such as China to Brazil attempt to rebalance, weighing on global demand and sending deflationary waves around the world through sharply lower oil and metals prices.
Already struggling with ultra low inflation after years of crisis, the ECB has all but promised policy easing on Thursday but the devil will lie in the details.
A small 10 basis point cut to push its deposit rate deeper into negative territory is a foregone conclusion while some type of adjustment of the bank’s 1.5 trillion euro asset purchase program is also near certain.
But each option on the table comes with side effects and limited functionality as monetary policy is deep in unconventional territory, making exotic decisions less likely given the difficulty of aligning the interest of 19 countries and 25 policymakers.
“Negative Interest Rate Policy (NIRP) seems to be all the rage in central bank circles these days,” Morgan Stanley said in a note to clients, arguing that such policies do not actually help bank lending.
“There are concerns amongst investors that the negative deposit rate will undermine the effectiveness of the ECB’s quantitative easing,” Morgan Stanley added. “This is because it effectively introduces a tax on excess bank reserves, i.e., effectively a tax on QE itself.”
A small majority of analysts also expect a 10 billion euro increase in monthly asset purchases while others predict an expansion of QE into new asset classes or a fresh push for targeted long term refinancing operations.
The ECB could also remove its self-imposed limits not to buy bonds yielding less than the deposit rate, a contentious move as it would mean certain losses on some assets, while a range of technical changes are possible.