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Eurozone headwinds to test ECB's confidence

Eurozone headwinds to test ECB's confidence

With trade tensions, an Italian government bucking at deficit limits and emerging market currency woes threatening the eurozone

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11.09.2018 04:11 PM

With trade tensions, an Italian government bucking at deficit limits and emerging market currency woes threatening the eurozone, observers will look to the European Central Bank for reassurance Thursday, while policymakers strive to project stability.

Since July, when ECB President Mario Draghi proclaimed "confidence" in the outlook for growth and inflation, "the balance of risks has become more unfavourable," say UBS analysts.

Back then, Draghi judged risks to growth in the 19-nation single currency area "broadly balanced".

On the downside, he highlighted trade tensions between the United States and its trade partners in China and the European Union.

With President Donald Trump now threatening to hit all imports of Chinese goods into America with tariffs, fears of a global economic slowdown triggered by protectionism have only grown.

Elsewhere, currency crises that have flared in major emerging economies Turkey and Argentina now risk undermining eurozone export partners like Germany and Spain -- although "the threat this turmoil poses to developed economies seems manageable for now," commented economist Marco Valli of Unicredit.

And within the euro area, all eyes are on Italy, where the governing coalition between the anti-immigrant League and anti-establishment Five Star parties will present their budget next month.

European authorities, other capitals and financial markets fear ministers will prioritise honouring pricey electoral promises over shrinking Rome's tottering debt pile of 132 percent of annual gross domestic product -- more than twice the EU target.

EU officials have reassured financial markets in recent days, but the so-called "yield spread" -- which measures the difference in perceived risk between Italian and ultra-safe German government bonds -- remains uncomfortably high.

Draghi generally prefers not to comment on individual capitals' fiscal plans, but regularly calls on highly indebted countries to set aside cash for a rainy day rather than indulging in spending sprees.

New forecasts

ECB watchers will also be keen to get their hands on new forecasts from the central bank staff looking as far ahead as 2020, but no major changes are expected.

"The bias for possible (small) revisions appears to be to the downside," wrote Unicredit's Marco Valli.

Nevertheless, "we expect ECB President Mario Draghi to reaffirm his confidence in the sustainability of the eurozone's economic recovery" and in the central bank hitting its target of inflation just below 2.0 percent, he added.

Analysts highlighted that while headline inflation reached 2.0 percent last month, "core" inflation -- which rules out volatile items like food and energy prices -- notched up just 1.0 percent.

And unemployment across the euro area remains stubbornly high compared with other advanced economies, at 8.2 percent -- limiting upward pressure on salaries and, indirectly, prices.

'Auto pilot'

For all the fears about risks to the growth and inflation outlook, the ECB appears unlikely to be swayed from its plans to end massive stimulus to the eurozone.

It announced in June that it would reduce mass bond-buying -- designed to pump cash through the financial system and into the real economy -- from the present 30 billion to 15 billion euros ($17.4 billion) per month from October, before ending them in December.

"The auto pilot, turned on in June, should stay on" at Thursday's meeting, economist Carsten Brzeski of ING Diba bank said.

Neither is Draghi likely to drop more hints about when interest rates may rise from the historic lows where they have been stuck for years.

They are set to remain there "at least through the summer of 2019," he reiterated last month.

More interesting for financial players could be hints about how the central bank will reinvest the proceeds as its massive 2.5 trillion-euro stock of corporate and government bonds matures.

Policymakers plan to buy new bonds with the payouts, hoping to influence markets and keep debt cheap long after ending their asset purchases.
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