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Europe has joined the US on the path to more stimulus

Posted at 6:16 AM, Jul 25, 2019
and last updated 2019-07-25 09:54:42-04

The European Central Bank has hinted that it will unleash more stimulus to help support the flagging eurozone economy.

The central bank held interest rates steady at record lows on Thursday, but it opened the door to its first rate cut since 2016 and the revival of bond purchases designed to spur economic growth.

In a statement, the ECB said that staff had been directed to “examine options” including new asset purchases and a policy that would mitigate the impact of lower interest rates on regional banks.

A rate cut in September now “looks very likely,” according to analysts at Capital Economics.

The euro weakened following the policy statement, and yields on government debt declined. The yield on 10-year German bonds fell further into negative territory, close to a record low of -0.42%.

The ECB has less room to maneuver than the US Federal Reserve, which is also expected to cut rates soon.

Mario Draghi, the outgoing ECB president, hasn’t raised rates once during his tenure. His quantitative easing program, which involved creating new money to buy assets such as government bonds, only ended in December.

European companies, and especially the region’s manufacturers, have been battered by rising trade tensions and continued uncertainty over Brexit. GDP growth is expected to slow to 1.2% this year.

Data published this week in Europe have bolstered the case for action.

On Thursday, the Ifo Business Climate Index showed that Germany’s economy started the third quarter with a whimper, with weakness across manufacturing, trade and services.

Eurozone manufacturing data for July was also was weaker than analysts had expected. One key manufacturing output index published Wednesday dropped to its lowest level since early 2013.

Draghi told reporters on Thursday that the risk of a recession is low, but the latest data showed an economic rebound was unlikely to materialize in the second half of the year.

The situation could be improved, Draghi said, by coordinated government spending in Europe.

Prodding reluctant governments into action could be a project for his successor. Christine Lagarde, who stepped down earlier this month as head of the International Monetary Fund, has been nominated to replace Draghi on November 1.

Draghi vs. Trump

The euro, which erased its losses as Draghi spoke, will probably weaken if the central bank moves ahead with stimulus.

That prospect has drawn the ire of President Donald Trump, who favors a weaker US dollar. The president lashed out last month on Twitter, saying ECB action would be unfair to American companies.

Asked about the issue on Thursday, Draghi said the ECB is focused on its mandate of keeping inflation just below 2%.

“We don’t target rates,” said Draghi. “We have an international consensus about avoiding competitive devaluations, and we stick with that international consensus.”