Biting the bullet

ECB easing would be better this month than next

The European Central Bank last eased policy six months ago. Mario Draghi insists more can be done if needed but so far he has mostly found excuses to prevaricate. This month may be no different - but it still would be the wrong decision.

Euro zone inflation has inched up, to 0.7 per cent in April, and the euro rally, which made imports cheaper, has paused. Banks are repaying crisis-era ECB loans in droves, a sign of reduced financial stress. True, this means there is less extra liquidity in the financial system. But, on the bright side, a rise in short-term money market rates isn't yet filtering through into longer ones. What's more, an ECB survey shows banks expect demand for loans to pick up in the second quarter.

Yet, these reasons aren't good enough to delay action. The Euro zone financial system still isn't working properly. The same ECB survey says "substantial" differences in lending supply conditions persist across the region, and credit standards remain tighter than the midpoint for the past decade. Nor will banks suddenly loosen standards, given how closely the ECB will scrutinise their balance sheets in this year's asset quality review. Meanwhile, overall lending remains weak, falling 2.2 per cent in March from a year earlier.

On top of all this, the ECB is missing its two per cent inflation target by a huge margin. Its own staff inflation forecasts - with midpoints of 1.0 per cent for 2014, 1.3 per cent for 2015 and 1.5 percent for 2016 - are likely to be cut in June. Delaying easing until they are formally trimmed is more dubious PR than healthy economics.

Draghi spelt out in a speech on April 24 how the ECB might react to different unwelcome scenarios. A rate cut could be one response to a stronger euro or money market tensions. If bank lending conditions don't improve, the ECB could start buying asset-backed securities. And, if the medium-term inflation outlook deteriorates, it could launch a more broad-based programme of asset buying - a prospect that Draghi later on deemed unlikely when talking to German lawmakers.

There are no easy options in this mix. But delaying the decision won't make it go away. The Euro zone economy needs help and would benefit from receiving it sooner rather than later.