IMF warns ECB against premature bond tapering
The International Monetary Fund has delivered a warning to eurozone monetary policymakers looking to wind down their bond buying spree, uring the ECB to keep its extraordinary stimulus in place until there is more evidence of inflationary pressures.
The European Central Bank is on the cusp of cutting back its €60bn-a-month quantitative easing programme in response to a stronger-than-expected economic recovery in the single currency area. A decision on slowing its bond purchases likely to come in October and apply from the beginning of 2018.
The central bank has already tweaked its message on its willingness to provide support to the economy – dubbed “forward guidance” – in June, removing a commitment to cut rates should the outlook worsen on signs that the region’s economy was growing well.
However, while growth in a region viewed as an economic laggard is now outpacing the US and the UK, inflation remains weak — registering 1.3 per cent in the year to June, below the ECB’s target of just under 2 per cent. Despite falls in unemployment, wage growth is weak, signalling that price pressures are unlikely to re-emerge in the real economy any time soon.
In its annual review of the eurozone economy, the IMF said that “monetary policy should remain firmly accommodative until there is a sustained rise in the inflation path” toward the target of 2 per cent:
The ECB’s forward guidance should remain unchanged until justified by actual inflation or by substantial evidence that the inflation outlook has improved.
Officials at the Washington-based institute also called on European governments to speed up efforts to fix the region’s banks, several of which have high volumes of non-performing loans and low profitability.
“[IMF directors] encouraged the European Commission to provide a blueprint for national asset management companies and clarity on State Aid requirements, which could help develop markets for distressed debt,” said the fund.
“Restructuring and consolidation in the banking sector should be incentivised by a firm approach to closing failing banks.”
Completing the banking union—with common deposit insurance and a common fiscal backstop— was “essential” to making banks safer.
The fund added that stronger European economies, such as Germany, Austria and the Netherlands, would need to tolerate inflation in excess of the central bank’s 2 per cent target to ensure that price pressures throughout the region remained broadly on track.
While that might seem like a statement of the obvious, higher inflation in the region’s core would almost certainly trigger pressure on the ECB to begin to tighten its monetary policies.
Despite this year’s surprisingly strong recovery, the IMF sounded gloomy on the region’s longer-term prospects:
Some high-debt countries could experience rising borrowing costs in the face of tighter global financial conditions or reduced monetary accommodation.
Structural weaknesses in the European banking system in the form of weak profitability and pockets of high non-performing loans could trigger financial distress. Moreover, political support for further European integration may be eroded by persistent external imbalances and lack of real income convergence.