ECB expected to hold its fire despite low inflation

The European Central Bank is unlikely to take new policy action at its monthly meeting on Thursday, despite a lingering threat of eurozone deflation and geopolitical risks.

Berlin: The European Central Bank (ECB) is unlikely to take new policy action at its monthly meeting on Thursday, despite a lingering threat of eurozone deflation and geopolitical risks, analysts said.

For now, the ECB is in "wait-and-see" mode to assess the impact of the unprecedented stimulus measures it announced in June, including taking one of its key interest rates into negative territory, they said.

Although the eurozone came out of recession last year and unemployment has fallen slowly, the Ukraine crisis and Western sanctions against Russia present a wild card of uncertainty.

But, despite worries over the East-West standoff, and very low eurozone inflation data for July, central bank-watchers did not expect the ECB and its chief Mario Draghi to announce new measures on Thursday.

"After the bold package announced in June, the ECB is now in a wait-and-see mode," wrote Marco Valli of UniCredit Economics, predicting a probably "fairly uneventful" meeting.

"The only meaningful change in rhetoric is likely to flag closer ECB monitoring of the downside risks from geopolitical tensions, as tougher sanctions against Russia start directly affecting some, so far limited, sectors of the euro area real economy, while uncertainty intensifies," he said.

For months, the other major worry has been the possibility of a plunge into deflation, or falling prices -- a dangerous twist which deters businesses and consumers from spending in the belief they can wait and buy more cheaply later.

If that happens, demand suffers and companies put off investment, hurting employment and setting off a vicious circle that can choke economic growth.

It is notoriously difficult for central banks to reverse deflation once the spiral has taken hold.Data last Thursday showed that eurozone inflation in July dropped to 0.4 percent. 

That was its lowest level since late 2009, in the aftermath of the global financial crisis, and far off the ECB`s target of just below 2.0 percent.

Howard Archer of IHS Global Insight called the inflation data "a blow for the ECB".

A silver lining was that the dip was mainly due to a year-on-year fall in volatile energy prices, leaving core consumer price inflation stable at 0.8 percent.

Archer said there was "a very real risk" that inflation could drop further, although he added that "we still expect the eurozone to avoid overall deflation".

"It certainly looks unlikely to move markedly higher any time soon, barring an appreciable rise in oil and gas prices resulting from geopolitical factors hitting supplies," he said.

At its June meeting, the ECB entered uncharted waters, taking one of its key interest rates into negative territory for the first time.

It lowered its benchmark refinancing rate to 0.15 percent and cut the deposit rate to minus 0.10 percent -- effectively charging banks for parking funds at the ECB, to encourage them to lend to businesses and consumers instead.

In positive news last week, an ECB survey said that eurozone banks had eased credit standards for loans to businesses in the second quarter for the first time since 2007.

In July, Draghi also promised billions of euros in cheap loans for banks to lend to businesses via the so-called Targeted Long-Term Refinancing Operation (TLRTO). 

Jennifer McKeown of Capital Economics said the ECB`s actions had already borne fruit, including falls in the euro exchange rate and in overnight interbank interest rates.

"With the measures announced in June seeming to have some positive effects on financial market conditions, the ECB is unlikely to announce additional policy support this month," she said.

"But further signs of economic weakness and the persistently low rate of inflation suggest that deflation risks in the eurozone have not receded."

Ultimately, she predicted, the ECB will respond with a broader programme of asset purchases.Archer of IHS Global Insight said that the bank would probably "sit tight through the rest of 2014", and that "the bar is very high for the ECB to engage in large scale, full blown quantitative easing".

This would only happen if inflation softened further, he said, adding that "we are doubtful that this will happen unless extended heightened geopolitical tensions contribute to a further loss of momentum in eurozone economic activity".

In this context, French Prime Minister Manuel Valls, struggling to reform the French economy widely seen as the weak link in the EU, had harsh words for eurozone policymakers in a speech on Friday.

"The economic policies of the eurozone are not efficient," Valls said, adding that they "sadly take a long time to have an effect".

"There is a real risk of deflation," Valls warned, "because at the European level, growth and inflation are lower than what we might have expected."