MNI POLICY: Fiscal policy, EZ weaknesses dominate ECB Account

By Luke Heighton

     FRANKFURT (MNI) - Fiscal authorities should play a "more decisive" role in

supporting the euro area economy and stabilising economic conditions, amid the

ongoing weakening of the economic outlook and the prominence of downside risks,

members of the European Central Bank's Governing Council concluded last month,

according to an account of its October monetary policy meeting.

     Overall, members shared chief economist Philip Lane's view that policy

measures announced in September should go unchanged, since they had "to a large

extent" preserved highly favourable financial conditions, but cautioned that the

negative effects of ECB monetary policy should also be given "due account."

     "All else being equal," the account notes, "the more that fiscal policy

contributed to boosting long-term growth potential and providing cyclical

stabilisation, the sooner the effects of monetary policy interventions on

inflation and the economy would be seen."

     A "strong call for [future] unity" was also made, in the wake of public

disagreement over the package of measures announced in September, with members

emphasising the need to demonstrate the Governing Council's "strong commitment"

to providing the necessary policy stimulus, the importance of forming a

consensus, and the need to "unite behind" the Council's commitment to pursuing

its inflation aim.

     At the same time, "a plea was made for patience to allow the measures taken

in September to work through the economy," as it was "underlined" that incoming

information since the September meeting had confirmed the "pronounced slowdown"

in euro area economic growth and a continued shortfall with respect to the ECB's

inflation target.

     Members saw a continued commitment to using the full set of instruments

available to the Governing Council, if the inflation outlook so required, as

"vital" - but also "cautioned that due account had also to be taken of the

assessment of possible side effects of monetary policy measures."

     --DETERIORATING SERVICES SURVEYS

     "Concerns were expressed" that the recent deterioration in survey data for

the services sector could reflect spillovers from persistently negative

developments in exports and manufacturing, and, indeed "there were initial signs

of some contagion from manufacturing to services, although it was too early to

speak of more generalised spillovers."

     "Some comfort could be drawn" from the relative resilience of

domestically-oriented sectors, consumer confidence and the only "limited"

effects of the downturn on labour markets "thus far." However, "reference was

made to the fact that the labour market could worsen if the economic weakness

were to persist."

     The dampening effect on headline inflation of low energy prices was

"emphasised," with the absence of major forecast errors for core inflation in

recent months supporting the projection of an upward movement in underlying

inflation dynamics, not least as the downward impact of changes in package

holiday prices associated with changes in German consumer expenditure weights

began to fade out.

     Nevertheless, "it was argued," the current weaker macroeconomic outlook

meant that an increase in underlying inflation "might not readily materialise."

It was also remarked that the most recent SPF indicated a downward-sloping path

for wage growth, coupled with a slight slowdown in wage dynamics. Doubts were

expressed as to whether profit margins would increase now, in the context of a

worsened overall outlook, when they had already failed to do so when the outlook

was more positive.

     The ECB's September switch to state-based forward guidance "more clearly

tied the likely path of policy interest rates to inflation prospects, while

providing a "clear guide" to the Governing Council's reaction function.

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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