Disagreements within the European Central Bank emerge, future crisis responses may bid farewell to the era of quantitative easing

The European Central Bank is at a critical crossroads. A survey shows that economists generally believe that in responding to future economic shocks, the European Central Bank will be more inclined to use targeted loan tools rather than the large-scale quantitative easing policies that have dominated crisis responses over the past decade.

Disagreements within the European Central Bank regarding short-term policy paths are also becoming increasingly evident. Although the market generally expects officials to pause interest rate cuts at next week's meeting, there are differing views among decision-makers on whether there will be a final rate cut this year and the specific timing. Most economists expect the European Central Bank to make a final cut of 25 basis points in September, but a considerable number believe that the final action may be delayed until December.

Behind this uncertainty is the ongoing struggle between hawks and doves within the European Central Bank's governing council. Officials, represented by Executive Board member Isabel Schnabel, believe that the threshold for another rate cut is "very high," while others, such as French central bank governor Francois Villeroy de Galhau, worry that if the euro strengthens further against the dollar, inflation may not reach the 2% target.

A deeper debate revolves around the future toolbox for crisis response. Another survey indicates that economists believe that due to concerns about the health of the central bank's balance sheet and policy credibility, the European Central Bank is likely to abandon large-scale bond purchase programs in future crises. This shift marks a potential farewell to the era of quantitative easing and a reconfiguration of its core strategy for addressing economic downturns.

Post-Quantitative Easing Era: Future Crisis Toolbox May Be Reshaped

A fundamental debate about the future policy tools of the European Central Bank is underway. According to a Bloomberg survey of economists, in almost all scenarios for future crisis responses, the European Central Bank would choose to provide loans to banks (such as Long-Term Refinancing Operations, LTROs) rather than purchasing bonds.

The survey results show that in response to weak inflation, sluggish economic growth, financial instability, or obstacles to policy transmission, boosting liquidity through LTROs is seen as the European Central Bank's preferred option. Only when interest rate signals fail to effectively transmit to individual member states of the eurozone do respondents expect the European Central Bank to activate tools designed for selective asset purchases in the past.

This shift in expectations reflects a cautious attitude among some European Central Bank officials towards the quantitative easing policies implemented from 2015 to 2022. This policy has led to record losses for some regional central banks, including the German central bank, after interest rates began to rise.

Regarding the choice of future tools, opinions within the European Central Bank are far from unified. French central bank governor Francois Villeroy de Galhau has stated that if the European Central Bank wishes to ease its policy stance, he prefers long-term bond purchases. In contrast, the German central bank takes a more reserved stance on quantitative easing and points out the associated risks of central bank losses.

Executive Board member Isabel Schnabel has warned that central bank losses could "damage credibility." She believes that asset purchases are a powerful tool for stabilizing markets, but they come at a higher cost when used to stimulate the economy. In contrast, targeted loans have proven effective in restoring credit supply and are also easier to reverse

Diverging Outlook on Rate Cuts, Trade Risks Become Key Variables

There is significant uncertainty regarding the timing of the next rate cut among the market and economists. Although most surveyed economists believe that the European Central Bank (ECB) can complete its final rate cut later this year, opinions within the industry are already divided. Fabio Balboni, a senior Eurozone economist at HSBC, stated:

"Some may view this (the pause in July) as just a pause, while others may see it as the end of the rate-cutting cycle. This could spark discussions about the interest rate path after July."

Survey data shows that about a quarter of respondents believe the ECB's rate-cutting cycle has ended. Nearly half of the economists predict the last rate cut will occur in September, while 21% believe it will happen in December. This divergence in views largely stems from the significant uncertainty in the external environment, particularly the trade negotiations between Europe and the United States.

Julie Ioffe, a European macro strategist at TD Securities, stated:

"The progress of trade negotiations between the EU and the US is the most critical aspect to watch, as it could disrupt the current balance between domestic strength and external demand."

She believes that, in this context, the ECB will be "unable to signal whether additional rate cuts are needed or whether the terminal rate has been reached." Currently, traders believe the likelihood of a rate cut in September is less than 50%, but market pricing has almost fully accounted for a rate cut before the end of the year.

Strong Euro and Inflation Outlook Challenge Decision-Makers

In addition to trade disputes, the persistently strong euro exchange rate and complex inflation outlook also pose challenges for decision-makers. Since the beginning of the year, the euro has risen nearly 12% against the US dollar, currently trading around $1.164. ECB Vice President Luis de Guindos stated earlier this month that $1.20 could be the level at which the economy begins to encounter difficulties.

However, economists' "pain threshold" seems to be higher. Only about a quarter of respondents agree with de Guindos' view, while others believe that the troublesome exchange rate level could be as high as $1.35. Many point out that when assessing the downside risks to prices, the speed of appreciation is as important as the exchange rate level itself, if not more so.

The inflation outlook is also fraught with variables. Surveyed analysts believe that the risks surrounding the ECB's June forecasts are roughly balanced. Their views on the likelihood of inflation overshooting or falling below target are almost evenly split. Dennis Shen, an economist at Scope Ratings, believes that the downside risks may be greater in the short term, as cheap goods affected by US tariffs may be redirected to Europe, thereby suppressing price pressures.

S&P Global Ratings economist Sylvain Broyer warns that:

"The increase in public spending may keep the core inflation rate above the target level."