ECB to consider fresh monetary stimulus

The European Central Bank (ECB) Governing council meets on Thursday (3 Dec). This meeting will be of particular interest as markets eye the consequences of a dovish ECB as against the US Fed which is widely expected to lift-off rates next month. In the run-up, ECB chief Draghi has provided strong indications that action will be taken to reverse the slowing recovery and subdued inflationary pressures. The mix of action could include a 10bps cut in the deposit facility rate to -0.30%, increase in the scale of the asset purchases and/or extension of the duration of the program beyond Sep 2016. Monthly increase of an estimated EUR 15bn in QE purchases and an extension to Mar 2017, for instance, will expand the ECB's balance sheet by another EUR 600bn, in addition to EUR 1.1trn in the existing program. 

While data improves at the margin, policymakers are concerned that existing economic slack and weak supply-side pressures will keep inflation far from the 2% target for longer than anticipated. Next set of staff projections are also due this week, which might see a further adjustment in growth and inflation projections. 

However the crucial question to be asked at this juncture is will more QE help? It seems unlikely. Apart from the psychological boost and the sharp euro depreciation, the first phase of ECB's QE has had a limited impact on the real economy. Significant economic slack and a negative output gap suggest the 2% inflation target will remain out of reach this year and the next. Moreover, the limited impact of QE in the US and Japan does not set an encouraging precedent. 

But that does not mean the ECB will sit on its hands. With Jan-Oct inflation near zero and growth yet to find a firm footing, authorities will remain vigilant about deflation risks. A deflationary environment would raise real interest rates, exacerbating some member countries' sizeable debt levels. The ECB's monetary conditions index also showed that real euro gains (post Mar15 QE announcement) have tightened monetary conditions. Therefore odds of further ECB action are high, even at the risk of a temporary and shallower impact on economic conditions.