Brexit may force ECB into more policy easing: analysts

By Balazs Koranyi

FRANKFURT (Reuters) - Britain's decision to leave the EU could force the European Central Bank into providing even more stimulus, just when it hoped it was done easing policy after years of extraordinary effort, analysts said on Friday.

Plunging confidence and market turmoil will dent investments and growth in Britain and the euro zone, weighing on inflation, even as the ECB is bending over backwards to boost consumer prices after it undershot its target for more than three years.

Indeed, markets are already pricing in almost 10 basis points worth of rate cuts by the end of the year while a key long-term inflation gauge fell to its lowest level at 1.32 percent on Friday, far from the ECB's target of almost 2 percent.

But the ECB is also unlikely to take hasty action, waiting at least until the September meeting, when new economic forecasts are presented, and using its July 21 meeting only to guide markets. It has repeatedly emphasized patience with its current measures, suggesting it would take its time to assess the impact.

"In the euro zone, spillovers from Brexit will materialize through trade, financial and confidence channels," UniCredit economist Erik Nielsen said. "Overall, we plan to lower our euro zone GDP forecast for 2017 to 0.5-1.0 percent from the current 1.6 percent.

Quick ECB reaction is also unlikely as the bank's inflation forecast may contain some buffer since the projections unveiled earlier this month did not fully incorporate the expected impact of approved but not yet implemented measures.

The ECB could cut its sub-zero deposit rate even further, though its room to manoeuvre is limited since negative rates weigh on bank earnings and curbing banks' ability to lend would counter the very stimulus the bank wants to provide.

The easiest step could be to extend the bank's 80 billion euro per month asset purchase programme beyond next March but new instruments are also possible, analysts added.

"Our forecast already anticipated further easing in September, in the form of an extension of the current asset purchase program through end-2017," JPMorgan economist Greg Fuzesi said.

"We now expect additional easing involving a 10 basis point cut in the deposit rate and a further extension of asset purchases into 2018," he added.

Such measures may need time to be devised since the ECB's asset buys, worth 1.74 trillion euros, were at risk of running into some of the bank's self imposed limits, so an extension could require the adjustment of some parameters.

Still, hinting at its willingness to take action, the ECB on Friday repeated that it would continue to fulfil its responsibilities to ensure price stability.

"The fall in oil prices and the weaker economy will drive the economy of the euro zone and Germany back into deflation," Marcel Fratzscher, the president of the German Institute for Economic Research said. "I expect that the ECB will ease monetary policy not just in the short term but also on the long term."

"The referendum... means that the period of zero interest rates will probably last significantly longer," Fratzscher said.

(Reporting by Balazs Koranyi; Editing by Dominic Evans)