Pimco Sees ECB Low Rates and Unconventional Policy as New Normal

Unconventional monetary policy and low interest rates are here to stay for the European Central Bank, according to Pacific Investment Management Co.’s Andrew Bosomworth.

The Munich-based portfolio manager believes the eurozone’s heavy reliance on exports, which make up about 47 percent of income, will make it hard for the ECB to raise rates much after the Fed is done hiking in 2020 and before the next global downturn hits. That means markets are probably too optimistic to expect borrowing costs to rise to 1.75 percent, he wrote in a blog post dated May 8.

With limited scope to cut policy rates, therefore, the ECB will have to use its balance sheet to counter deflationary pressure when confronted with the next recession.

Bosomworth expects long-term refinancing operations to become a standard tool in ECB’s arsenal. The fixed-rate, full-allotment regime, which allowed the central bank to flood the financial system with liquidity, is also here to stay. The ECB could also start receiving interest rate swaps while buying private sector assets and will probably scrap its self-imposed limit on government bond purchases, he says.

Pimco is not alone in thinking that there is no going back to the old ways of central banking. Speaking in Malta on Friday, the outgoing ECB Vice-President Vitor Constancio said it was doubtful monetary policy could remain effective by returning to small central-bank balance sheets and held out the possibility of “mild corrections” to inflation targets.

These challenges are probably something for the next ECB president to consider. The current one, Mario Draghi is expected to wind down bond-buying this year and start raising interest rates before his term ends in October 2019. Still, the years ahead “might be but a brief interlude to a new phase of unconventional monetary policies,” Bosomworth said.

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