Bond purchases and low inflation in focus at ecb

Frankfurt (Reuters) – Stock market tremors, China worries and inflation frozen at the zero line are all piling up on ECB President Mario Draghi's desk as the vacation season ends.

Financial market players are puzzling over whether Draghi will hint at a possible expansion of the monetary watchdog's giant bond-buying program following Thursday's Governing Council interest rate meeting. Some experts also believe that the Italian may then present somewhat lowered forecasts of his staff on inflation trends because of the notoriously low inflation in the euro area. The key interest rate, which has been at a record low of 0.05 percent for some time now, is not expected to be touched by the ECB.

The ECB is expected to sound "slightly concerned" on Thursday, said Pernille Bomholdt Henneberg, an analyst at Danske Bank. "Draghi will put much more emphasis on the risks to the economic outlook following recent developments in China and the sell-off in equities," she said. ECB chief economist Peter Praet already acknowledged a few days ago that the risks had increased due to developments in the global economy and commodity markets that the euro watchdogs could miss their medium-term target of inflation of just under two percent. "There should be no misunderstanding that the Governing Council is willing and also able to act if necessary," he said. In July, inflation was just 0.2 percent.

Since March, the ECB and the national central banks have been pumping billions into the financial system week after week by buying government bonds of the euro countries in order to stimulate the economy and drive up what they see as dangerously low inflation. However, the big push for inflation has so far failed to materialize. The program, which will run until at least September 2016, is expected to total 1.14 trillion euros, including covered bonds and mortgage-backed securities (ABS).

Brent and WTI crude oil prices have each fallen by almost 30 percent since June. In addition, worries about a continuing economic slowdown in China would trigger severe turbulence on the financial markets. If the world's second-largest economy were to stumble in the long term, this would have repercussions for the economy in the currency area. In addition, the prices of commodities such as oil are likely to fall even further. As a result, important inflation barometers [ID:nL5N10Z1MC] have already fallen on the financial market. According to economists, this is not likely to please Draghi and his colleagues on the council. "The central bank is likely to be particularly disappointed by the development of market-based inflation expectations, which have been falling noticeably of late," said Commerzbank chief economist Jorg Kramer and his colleague Michael Schubert.

In its own forecasts, the central bank has so far projected inflation of 0.3 percent this year, then 1.5 percent in 2016 and 1.8 percent in 2017. For some experts, meanwhile, that's a bit too optimistic: "We expect a slightly lower forecast for 2017, driven mainly by the low oil price," says Danske Bank analyst Henneberg.

But the big question on Thursday will be whether the clouded inflation picture is enough for the ECB's Governing Council to increase the firepower of its mammoth bond-buying program after less than five months already. Experts at the investment bank Morgan Stanley, for example, do not want to rule this out completely. Like them, however, most experts remain skeptical. Commerzbank economists Kramer and Schubert sum up the reasons: If the ECB were to announce a significant increase in purchases now, "this would also be an admission that the measures taken so far have been inappropriate."Whether such a step would be positively received is therefore by no means clear.

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