Eurozone lending contraction compounds ECB’s headache

ECB president Mario Draghi (right) and vice-president Vitor Constancio arrive for a news conference at the bank’s headquarters in Frankfurt. Draghi reiterated that the bank will take action if the outlook for inflation worsens or money-market turbulence resumes.Reuters/FrankfurtLending to households and firms in the eurozone fell again in January and money supply growth remained subdued, adding to pressure on the European Central Bank to take action next week to support the economy.The ECB has cut interest rates to a record low, pumped extra liquidity into the banking system and announced a fresh government bond purchase programme, but the measures have so far not managed to unclog lending to the real economy.Eurozone inflation is also running at only 0.8% — far below the ECB’s target of just under 2%.Loans to the private sector fell by 2.2% in January from the same month a year earlier, ECB data released yesterday showed. That compared to a contraction of 2.3% in December.Eurozone M3 money supply — a more general measure of cash in the economy — grew at an annual pace of 1.2%, picking up slightly from 1.0% in December.“Weak money supply growth is not only condemning the eurozone to stagnant recovery, but it is raising the odds that the single-currency area could easily slip back into recession again,” said David Brown at New View Economics.“The ECB still needs to think outside the box to get the eurozone motoring into the fast-lane,” he added. “A change of heart on quantitative easing still beckons ahead.”The ECB, worried that inflation risks getting stuck in a “danger zone” below 1%, is considering whether to take fresh policy action next Thursday to support the economy.After its February 6 meeting, ECB President Mario Draghi said the bank had decided not to act while it acquired more information on the growth and inflation outlook and assessed the impact on the eurozone of turmoil in emerging markets.“We are reflecting 360 degrees on everything,” Yves Mersch, who sits on the six-member Executive Board that forms the nucleus of the Governing Council, said on Wednesday.The ECB has set out two scenarios that could trigger fresh policy action: a deterioration in the medium-term inflation outlook and an “unwarranted” tightening of short-term money markets.Before the ECB gets to quantitative easing — a policy option about which many of the bank’s policymakers have deep reservations — a cut in interest rates is one option for dealing with low eurozone inflation, or tight money markets.Another option the ECB has discussed is to suspend operations to soak up the money it spent buying sovereign bonds under its now-terminated Securities Markets Programme (SMP) during the eurozone’s debt crisis.“I think it’s now nearly a foregone conclusion that they would either stop the sterilisation of the SMP, or maybe reduce it by a large extent,” said Francesco Papadia, former head of the ECB’s financial market operations.“Whether this would be accompanied by something else, I don’t know. My sense is that if they do this, they could be content for a while. Still, the inflation projections for 2016 will be very important,” he added.At their meeting next week, ECB policymakers will have at their disposal new forecasts from the bank’s staff that will stretch into 2016 for the first time.