Time to be bold

ALTHOUGH the European Central Bank (ECB) is often accused of timidity, it has nonetheless acted decisively on occasion, notably by pledging in 2012 to buy unlimited amounts of government bonds under siege from the markets. Still untested, this commitment is widely credited with saving the euro. Now the ECB faces a different danger from a long spell of low inflation, currently just 0.7%, well below its target of almost 2%. The longer this persists the greater the risk of a slide into deflation, imperilling countries laden with excessive debt. When the bank’s governing council meets on June 5th it is likely to adopt a battery of measures to counter “lowflation”.

After the council’s meeting in May Mario Draghi, the ECB’s president, came close to pre-announcing bold action in June. The council only waited, he said, to see the bank’s next round of economic forecasts. These seem sure to show worryingly lower projections of inflation than those of March, which envisaged prices rising by 1% this year and 1.3% in 2015. More recent estimates from the OECD were lower, at 0.7% and 1.1% respectively.

Any remaining doubt that the new forecasts would provide grounds for a move in June was dispelled by disappointing growth of 0.2% in the first quarter. Since the recession ended last year, the recovery has been a muted affair (see chart). Adding to the gloom, the meagre growth was unbalanced. The German economy, the biggest in the euro zone, expanded by 0.8% (or 3.3% at an annualised rate). But even though the growth came from domestic demand, creating opportunities for exporters in the rest of the euro zone, performance elsewhere was dismal. In particular, the French and Italian economies, the euro area’s second- and third-biggest, did badly. French output stagnated while Italian GDP, which had been expected to record a second quarter of modest growth following its long double-dip recession, shrank by 0.1%.

The wan performance makes an easing of some sort in June a done deal, but the shape and ambition of the planned measures remain unclear. The ECB’s own forward guidance—to keep its policy rates at “present or lower levels for an extended period of time”—suggests that a cut in interest rates is on its way. The bank last cut its main lending rate in November, from 0.5% to 0.25%. This could be lowered again, to 0.15% or 0.1%. Since the rate is already so low, the effect of such a move would be small. So the ECB is also expected to cut the rate it pays to banks for overnight deposits from zero to minus 0.1%, in effect charging them for taking their money.

This would be a first for a big central bank, although the National Bank of Denmark recently ended a nearly two-year period of negative deposit rates that helped curb upward pressure on the krone, which is tied to the euro. The ECB has been anxious about the strength of the euro, which has risen by 6% against the dollar over the past year, but for a different reason: its contribution to low inflation. As well as countering currency appreciation, negative deposit rates may encourage banks in the euro zone to lend more to one another—something still impeded by misgivings about the creditworthiness of banks in struggling peripheral economies.

Banks may react to negative deposit rates at the ECB by raising their lending rates to firms and households. This is one reason why more measures to ease policy are expected. The ECB may for example stop trying to mop up the money created when it bought peripheral-government bonds in 2010-12. Its current holdings are worth €167 billion ($229 billion). It may also try to ease credit for smaller firms in southern Europe by lending cheaply and for a long time to banks on the condition that they pass the money on to businesses.

Having waited too long to ease monetary policy, the ECB will have to act decisively. But the bank still appears reluctant to use the best potential weapon against lowflation: a large programme of asset purchases, or “quantitative easing”.