ECB pledges more easing and opens door to goal review

FRANKFURT (Reuters) - European Central Bank President Mario Draghi all but pledged to ease policy further as the growth outlook deteriorates and even hinted on Thursday at a reinterpretation of the ECB’s inflation target, the cornerstone of its entire policy framework.

Draghi said the euro zone’s central bank was looking at interest rate cuts, fresh bond buys and new policy guidance to lift persistently low inflation, which has undershot its target for the past six years — most of his eight-year term.

With a global trade war sapping confidence, Europe’s export-focused manufacturing sector has been in free-fall recently. That threatens to infect a so far resilient domestic economy which is yet to fully recover from the bloc’s debt crisis.

“This outlook is getting worse and worse, and it is getting worse and worse in manufacturing and getting worse and worse in countries where manufacturing is very important,” Draghi, who will step down on Oct. 31, told a news conference.

The ECB has targeted inflation ‘close to but below’ 2% for 16 years but Draghi said that after the prolonged shortfall, the target is considered symmetric and there would be no cap at 2%.

He said some policymakers were even advocating a wholesale change to the inflation target for the first time since 2003.

“We don’t like what we see on the inflation front and symmetry means basically there is no 2% cap,” Draghi said.

“We don’t accept permanently lower inflation and symmetry means the Governing Council will act with the same determination whether inflation is above or below the inflation aim.”

Allowing inflation to run above 2% for some time to compensate for missing the target could be seen as a de facto increase to the target, a move some policymakers warned against at June’s ECB meeting, according to published minutes.

After the bank kept rates unchanged on Thursday, Draghi said it was devising a stimulus package, possibly for September.

In a precursor to a rate cut, the ECB said it saw rates at present or lower levels through mid-2020, a subtle change to its previous pledge to keep rates unchanged through next June.

Draghi added that the ECB could also compensate banks for even lower rates by offering a multi-tier deposit rate. That would shield them from what is effectively a charge imposed on excess reserves they hold securely at the ECB.

DISMAL PICTURE

The increasingly overt promises of more stimulus are intended to prop up confidence in the euro zone economy, which is struggling with a manufacturing recession that risks unraveling years of stimulus.

While consumer confidence, employment and bank lending remain healthy, a recent string of industrial sentiment indicators paint a dismal picture, raising the risk that weak external demand, partly the result of a global trade war, could soon infect the domestic economy.

The euro EUR= initially eased on the ECB's decision but then reversed course during Draghi's news conference to trade at 1.1162 to the dollar, compared with around $1.113 before the bank's announcement.

Germany’s 10-year bond yield DE10YT=RR, a benchmark for the bloc, initially fell to around -0.41%, close to a record low before moving up to -0.37%.

The case for ECB stimulus is supported by weak economic data, particularly in foreign trade and manufacturing, the engine of the euro zone economy’s recent growth run.

Indeed, the German Ifo institute warned earlier on Thursday that recession was spreading across all important sectors of German industry and sentiment was deteriorating quickly.

“There is far and wide nothing to be seen of the second-half recovery hoped for in many places,” Commerzbank economist Joerg Kraemer said. “Germany is in a gray area between a marked growth slowdown and a recession.”

Whichever measures the ECB opts for will come with complications and have only limited potency given that the bank has already exhausted much of its firepower in the wake of the euro zone debt crisis that peaked in 2012.

Rates are already at record lows and the ECB’s balance sheet is equivalent to 40% of the block’s economic output, suggesting that the limits of its stimulus are near.

Buying more government bonds could also create problems for the bank, as it is at or near its self-imposed limits for several of the 19 euro zone countries.

While policymakers say they have leeway to adjust their rules, critics of the bank’s asset purchases, who have already launched several legal challenges, would be almost certain to take the ECB back to court.