Christine Lagarde has been in charge of the European Central Bank for only four months but her decisive test has come early in her term of office: how to respond to the economic impact of coronavirus.
The US Federal Reserve’s emergency rate cut on Tuesday piled pressure on other central banks to take action, too — none more so than the ECB, whose rate-setting committee meets next week.
As well as being the first major central bank to hold a scheduled meeting since coronavirus hit the global economy, the ECB is also among those with the least room for manoeuvre, having failed to lift rates once the economy started to improve as the Fed has done several times in recent years.
Eurozone interest rates are at a record low of minus 0.5 per cent and debate about the adverse impact of negative rates has intensified across Europe in recent months.
Ms Lagarde has so far sought to resist calls for an early rate cut. In a statement on Friday Mr Powell promised to act “as appropriate” to support economic growth — a clear signal of the upcoming rate cut which he then announced on Tuesday — but Ms Lagarde has said only that the ECB is “ready to take appropriate and targeted measures, as necessary and commensurate with the underlying risks”.
After the 2008 financial crisis erupted, the ECB earned a reputation for being slower than other major central banks to take action; Ms Lagarde’s hesitancy risks recreating the impression that the ECB is once more behind the curve.
By contrast the Bank of Japan has promised to inject liquidity into markets, and Bank of England governor Mark Carney said on Tuesday that he was prepared to cut rates if necessary.
“She is really stuck between a rock and a hard place,” said Frederik Ducrozet, strategist at Pictet Wealth Management. “No one I know expects a rate cut to have any impact on the eurozone economy — it could even be counterproductive — but there may be no choice.”
The case for monetary policy action is clear: economists are slashing their growth forecasts, with many predicting the eurozone will slide into a recession in the six months to June — its first since the bloc’s sovereign debt crisis in 2012.
Coronavirus is causing serious economic disruption in Europe: companies are restricting staff travel, tourists are calling off their plans, airlines are scrapping flights, sporting events are being cancelled and factories are preparing for supplies of Chinese goods to dry up.
Supermarket shelves across Germany have been left bare in recent days as shoppers buy up all the toilet paper, tinned tomatoes, pasta and disinfectants they can find — a behaviour nicknamed Hamsterkäufe, or shopping like hamsters.
Yet stockpiling is unlikely to provide much of a long-term boost to the economy.
Adding to Ms Lagarde’s dilemma, there is little hard economic data available yet to show how hard the economy has been hit — and that is unlikely to change much by the time the ECB governing council meets on March 12, when it is also due to update its economic forecasts.
Ms Lagarde’s statement on Monday hinted that ECB officials are working on the expansion of its programme of cheap loans for banks, which is designed to provide incentives for them to keep credit flowing to companies via the targeted longer-term refinancing operation (TLTRO) which the ECB relaunched last year.
The ECB could offer loans to banks at negative interest rates on the condition that they keep lending to small businesses affected by the disruption of the virus, either by repurposing its existing TLTRO programme or launching a new one.
Mr Ducrozet said the ECB might need to go further by cutting rates and increasing its bond purchases if the euro keeps rising against the US dollar, fuelled by the Fed’s latest move.
Investors are pricing in a more-than-75 per cent chance that the ECB will cut rates to minus 0.6 per cent next week and lower them further later in the year.
“The ECB will probably not want to forego the signal effect of an interest-rate cut in order to make a greater impression on the market,” said Jörg Krämer, chief economist at Commerzbank.
However some economists doubt whether cutting rates will do much to ease the economic pressures of coronavirus. Measures introduced to contain the disease have created a supply shock for the economy, but monetary policy is generally more effective in addressing a shortfall in demand rather than disruptions to supply.
“On the supply side there is not much the ECB can do, beyond providing liquidity to specific sectors affected by the virus,” said Danae Kyriakopoulou, chief economist at central bank think-tank OMFIF.
Ms Lagarde’s task is further complicated by divisions in the ECB’s main rate-setting committee, which blew up into a bitter public spat last autumn when it last cut rates and restarted its bond purchases, shortly before Ms Lagarde became president.
“Ms Lagarde has said she wants to respond more to the real economy and not just financial markets,” said Ms Kyriakopoulou. “But there is also a question over divisions within the governing council and how much support there would be for action.”