Pictet: "Holding out for a hero - the euro zone and the ECB"

Euro zone inflation has stayed below 1 per cent for more than two years despite a series of monetary stimulus measures from the European Central Bank. Mickael Benhaim, Co-Head of Global Bonds, outlinesthe likely next step for the central bank as it tries to kick start credit growth and revitalise the economy.

He was once hailed as “Super” Mario. Now, he seems to be losing that aura of invincibility. In common with many of his counterparts in the developed world, European Central Bank President Mario Draghi looks to have run out of bright ideas to rescue the economy. Indeed, his recent decision to chargeprivate institutions for the privilege of parking their surplus reserves with the ECB was derided as short-sighted in some quarters. While the move was intended to boost consumer and business lending, critics claim it is more likely to do the opposite, chiefly because it will squeeze banks’ profit margins.

But there are ways for Draghi to re-establish his credibility with investors and businesses – and his options include further relaxing restrictions on the ECB’s government bond purchase programme and buying corporate debt. Bold steps, clearly, yet moves that would be in keeping with his pledge to do“whatever it takes” to safeguard the euro zone.

Diminishing returns 

Those who claim the ECB is becoming less effective have a long charge list. The euro zone economic growth is slowing: Germany’s manufacturing sector, for instance, registered a 1.1 per cent month-on-month decline in output in December. Meanwhile, inflation sits stubbornly below the ECB’s 2 per cent target, and has done so for four years. Core inflation slowed to just 0.7 per cent in February while the most widely followed measure of the market’s long-term inflation expectations, the five-year five-year forward breakeven inflation rate, recently hit a record low of 1.37 per cent. Then, there is the problem of non-performing loans on bank balance sheets. Italy alone has some EUR350 billion worth of them – and they account for some 17 per cent of the country’s total bank loans. This has contributed to an alarming fall in credit growth (see Fig. 1).

For all this, it would be a mistake to assume that central banks have run out of ammunition. Far from it. Like its peers, the ECB still has quite an arsenal at its disposal. And I believe it will use its March 10 policy meeting to breathe new life into its campaign to create the conditions for self-sustaining economic growth.

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