Outside-the-Box Guide to ECB Policy as Economic Going Gets Tough

(Bloomberg) -- The European Central Bank may have more policy options at its disposal than cheap loans for banks if the euro-area slowdown worsens.

The scale of the economic weakness means the ECB will cut its growth and inflation forecasts on Thursday, and policy makers have set the scene for a debate on their response, including guidance on interest rates and support for banks. The latter is seen among the most likely steps, though a final decision may not happen at this week's meeting.

With a restart of bond purchases seemingly off-limits for now, economists have also been looking at more creative solutions.

Easing by Raising

Negative rates have become a pet peeve for some euro-area banks because they can't pass them on to depositors, and some policy makers have caught on to the problem -- France's Francois Villeroy de Galhau has highlighted “possible adverse consequences” for the transmission of monetary policy.

According to Louis Harreau, a strategist at Credit Agricole, the ECB could raise its deposit rate from minus 0.4 percent and pledge to keep it at zero for another 18 months. That would help banks and still keep policy loose, he says. UniCredit's Erik Nielsen argues policy makers should abandon negative rates or exempt all but the largest deposits from the penalty.

Yet, solutions mitigating the impact of sub-zero rates or even an increase in borrowing costs may prove difficult to communicate against the backdrop of a deteriorating economy.

The so-called tiering system could create a perverse impression that negative rates will remain in place for much longer, says Goldman Sachs economist Lasse Holboell Nielsen. It would also bring no relief to Italy, where banks are already turning the screws on lending, according to HSBC.

New Loans

Renewing more than 700 billion euros ($793 billion) in longer-term funding will likely be hotly debated at the Governing Council meeting. Current loans start to expire next year and a new round of cheap financing could ease pressure on banks.

But not everyone is keen. Spanish CaixaBank Chief Executive Officer Gonzalo Gortazar said last month that banks don't need new ECB-subsidized loans. Spanish lenders were the second biggest takers of the so-called TLTROs after Italy.

The terms will be key. Funding that locks in a rate for a fixed period could be read as the ECB telegraphing its policy intentions. Loans with floating rates would provide more flexibility, but also look less attractive for banks.

Officials could also offer sweeteners for boosting mortgage lending to prop up consumer confidence, according to Societe Generale. Yet the idea may not sit well with countries like Netherlands, where the central bank is worried about rising property prices.

Buying Risky Assets

If all else fails, the ECB could also start buying risky assets directly from euro-area banks to prevent another crisis, says Thomas Mayer at Flossbach von Storch Research Institute in Cologne and a former former Deutsche Bank chief economist.

For now this sounds like a nuclear option that President Mario Draghi would gladly leave for his successor to consider.

To contact the reporter on this story: Piotr Skolimowski in Frankfurt at pskolimowski@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Jana Randow

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