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    European Central Bank to Wrap Up Stimulus Despite Uncertain Outlook

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    Amid the mounting concerns over Italy’s debt, a possible “hard Brexit,” disruptions in global trade, and economic slowdown in China, the European Central Bank (ECB) is committed to changing its policy course in order to prepare the Eurozone for future economic shocks.

    Kristian Rouz — Officials at the European Central Bank (ECB) say they remain committed to downsizing bond purchases and eventually increasing base interest rates, despite Brexit fears and the rising concern over Italy's budget and debt.

    The ECB is, however, expected to acknowledge a deteriorating outlook for the Eurozone's economic stability at its upcoming policy meeting.  But policymakers say existing concerns are unlikely to derail their plans to end the unconventional monetary stimulus.

    READ MORE: Brexit Will Reportedly Prompt Germany to Pay Extra Billions to EU Annually

    The ECB's combination of zero-to-negative interest rates (known as ZIRP and NIRP, respectively) has entered its fifth year, and officials are seeking to retreat from these stimulus programs due to the Eurozone's economy having accelerated over the past year.

    "The ECB seems determined to end its net asset purchases — almost no matter what," Florian Hense of the German bank Berenberg said.

    Economists say the ECB's ultra-accommodative interest rates have exhausted its ability to address future challenges to economic stability. They suggest that in case of an economic downturn in the near-to-medium-term, the ECB would have no room to cut interest rates further or expand its bond-buying program to support commercial lending and Eurozone investment.

    But in a broader macroeconomic and political context, reality could challenge the ECB's planned pivot to tighter monetary policies.

    "The current 'risk-off' mode in financial markets, developments in Italy and a rising risk of a hard Brexit provide plenty of reasons to sound a more cautionary note," Dirk Schumacher of the French investment bank Natixis said.

     One year ago, the ECB's Governing Council decided to implement gradual cuts to its bond-buying program. At the time, the ECB's purchases of commercial bonds from the open market were cut in half, allowing for a greater market competition and higher yields on the European bond market.

    READ MORE: Italy's Flight From Eurozone Would Be Liberation, Not Punishment — Eurexit Chief

    Although the Eurozone's investment appeal has improved ever since, with inflation and GDP growth accelerating accordingly, the ECB is aware of the risks to its planned policy adjustment.

    According to a recent Bloomberg survey of Eurozone economists, a possible Italian budget crisis is currently being seen as the greatest challenge to the ECB's expected monetary tightening. Italy's government recently unveiled a budget for the 2019 fiscal year, with lower revenues and heightened expenditures challenging the sustainability of the country's national debt.

    The European Commission has requested a review of Rome's budget proposal, but experts say the lingering fragility of Italy's banking sector could add to the turmoil.

    "If anything, expect a re-assessment of risks: The ECB could downgrade the risks to the outlook from broadly balanced to tilted to the downside," Berenberg's Hense stressed.

    The Bloomberg poll also found most economists agree the ECB faces the challenges of global trade tensions and a possible economic slowdown in the Eurozone. If these two risks materialize, the ECB will have to abstain from raising interest rates — as tighter monetary conditions typically hold back broader economic expansion.

    Among additional risks, which economists evaluated as balanced to low risks, are the ongoing slowdowns in the Chinese economy and a possible financial crisis in the emerging markets.

    Although the Eurozone maintains a significant volume of bilateral trade with China and the rest of the developing world, these risks are seen as unlikely to derail Germany's robust exports, intra-EU trade, and investment, or domestic consumer demand in the Eurozone — the three main pillars of growth in the single currency area.

    However, inside the EU, economic momentum appears to be fading is the face of Brexit. According to a recent Purchasing Managers' Indices (PMI) from IHS Markit, euro-area manufacturing has slowed from a reading of 55 to 52 over the past few months, while services have cooled from 54 to 53.

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    PMI readings above 50 still indicate expansion, which seems to have slowed due to a combination of the aforementioned risks.

    Such developments "would historically be consistent with a bias toward loosening monetary policy," IHS Markit's experts observed, whilst the ECB seeks ways to tighten its policies.

    Meanwhile, the Eurozone's inflation is currently at 2.1 percent — above the ECB's 2-percent target, which is quite encouraging both for the policymakers, investors, and business owners.

    "Better news is that wages data for the euro area as a whole have probably been firmer than anticipated —stronger pay growth is key to the ECB meeting its inflation objectives," Jamie Murray and David Powell of Bloomberg Economics wrote.

    In light of this, ECB officials are expected to lay out a plan to mitigate the macroeconomic risks, whilst still pushing to end stimulus policies in order to ensure a greater sustainability of the Eurozone economy.

    This might come at a price of a slower economic growth across the common currency area, but monetary tightening appears to be necessary to better prepare the Eurozone for future economic shocks.

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    Brexit, economy, manufacturing purchasing managers' index (PMI), Eurozone, The European Central Bank (ECB), United Kingdom, European Union, Italy
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