MNI ANALYSIS: Looming Trade War May Complicate ECB Policy Exit

--Draghi Concerned Over Second-Round Effects On Economy 

--European Investor Confidence Sharply Lower In March On Trade Fears

By Christian Vits

     FRANKFURT (MNI) - The European Central Bank appears increasingly concerned

over the prospect of a looming trade war as an escalation of tensions would

cloud the economic outlook and could complicate the bank's exit from its

extraordinary measures.

     After its last policy meeting the bank assessed the risks surrounding the

euro area growth outlook as "broadly balanced". But a few days later, ECB

President Mario Draghi warned that a trade war could hamper economic growth and

"conspire to reduce our confidence in the inflation path".

     First-round effects on the euro area are likely to be small, even if there

is symmetric retaliation from U.S. trading partners, according to Draghi.

However, there could be a follow-through effect.

     "There are potential second-round effects that could have much more serious

consequences. These include the risk of retaliation across other goods (...) and

the potential for negative confidence effects, which would weigh on business

investment in particular," Draghi said.

--COMPLICATED EXIT

     The intention of the U.S. administration to impose new trade tariffs may

not only tarnish the outlook for economic growth in the euro area but, beyond

that, it would also increase uncertainty in financial markets, most likely

resulting in higher risk premiums.

     In conjunction with a sustained appreciation of the euro, exerting downward

pressure on prices, this could lead to a dangerous cocktail mix for the ECB.

     A trade war would certainly make the ECB's task in normalising monetary

policy more difficult, as the bank on one hand needs to increase its headroom

for manoeuvre in order to deal with the next downturn and, on the other hand,

keep the current economic recovery on track.

     Claudio Borio, Head of the Monetary and Economic Department of the Bank for

International Settlements in Basel, recently warned that the path for

normalising policy is "a narrow one", adding that "the most recent protectionist

rhetoric complicates matters further."

--FIRST REPERCUSSIONS

     The punitive tariffs on steel and aluminium imports announced by U.S.

President Donald Trump could come into effect as early as next Friday. Trump has

also threatened to impose levies on European Union car imports.

     The debate about U.S. trade measures also already had a negative impact on

investor confidence in the Eurozone. The ZEW Indicator of Economic Sentiment,

published Tuesday, took a hit in March and fell to 5.1 points, the lowest

reading for Germany since September 2016. Investor sentiment was also sharply

lower when looking at the entire eurozone.

     "Concerns over a US-led global trade conflict have made the experts more

cautious in their prognoses," ZEW President Achim Wambach commented Tuesday.

     The German IfO Institute sees the risk of protectionism spreading to other

sectors and countries as a result of the U.S. measures.

     "This could undermine the World Trade Organization and seriously jeopardise

the progress achieved in liberalising world trade over the past decades,"

Gabriel Felbermayr, Director of the Centre for International Economics at the

renowned think tank, said Monday.

--G20 TALKS

     Still, the world may not yet be on the brink of an escalation of

protectionist measures. G20 finance ministers are currently gathering in Buenos

Aires, with the trade issue on top of the agenda.

     The G20 communique may not change much compared to March last year, when

the U.S. insisted on dropping the commitment to avoid "all forms of

protectionism", a term which was replaced by the objective to avert "unfair"

trade.

     Indeed, the EU is not yet free trader's paradise for outsiders. The

unweighted average EU customs duty is 5.2%, versus the comparable U.S. rate of

3.5%, according to the IfO Institute.

     At the same time, permanent threats and accusations by the U.S.

administration come at a price: even before Trump's measures are been

implemented, the repercussions for confidence in the world's economic recovery

are already being felt -- and that will make life more difficult for the ECB.

--MNI Frankfurt Bureau; +49 69 97782671; email: christian.vits@marketnews.com

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