MNI SOURCES: ECB Hawks Hang On As Downturn Fears Gather

--Debate To Centre On First Rise In Deposit Rate

--Decision Closer On Fresh TLTROs

     LONDON (MNI) - The European Central Bank is increasingly concerned a

deepening economic slowdown could prove longer-lasting, but more hawkish members

of the Governing Council will want to see more data before abandoning hopes of a

rise in the deposit rate this year, Eurosystem sources told MNI.

     While no serious discussion is likely before the ECB's March meeting on

whether to recalibrate its current guidance for interest rates to remain at

current levels at least through the summer, not all on the Council are in line

with a growing market consensus for a first hike some time in 2020, one source

said. Estonia's Ardo Hansson and Germany's Sabine Lautenschlaeger are among

those who still favour a change in the deposit rate from its current -0.4% this

year, the source said.

     "Clearly, there is going to be a controversial discussion although if the

data gets even worse that controversy may die down," the source said, adding

that a confirmed pause in the Federal Reserve's rate-hiking cycle could

nonetheless sway the hawks towards delaying a hike and that if a recession

occurred guidance could change towards the end of the first quarter.

     But another Eurosystem source told MNI that, given the long lead-in to the

current guidance, any change would be unlikely before the ECB's June

macroeconomic forecasts. Some Governing Council members want hikes postponed

until at least early 2020, the source said, adding that the main debate would

concern the timing of raising the deposit rate: "Some think it should be raised

only in small steps; others want to get out of negative territory as soon as

possible. So the size of the rise will also become an important issue as we come

closer to the June meeting."

     --RISKS MOVING TO DOWNSIDE

     The only possible move at the ECB's Jan. 24 meeting would be further

adjustment to its assessment of the balance of risks, which it downgraded in

December from "broadly balanced" to "broadly balanced" but "moving to the

downside", the first source said.

     While a fall in the oil price has reduced inflationary pressure, some

officials are also concerned rising wages are failing to feed through to higher

consumer prices. China's economic slowdown, as it is locked in a trade dispute

with the U.S., is sapping demand for eurozone exports. The danger that the U.K.

could also leave the EU without any withdrawal agreement also casts a shadow

over the economy's prospects, officials said.

     "It depends very much on finding a solution to the China-U.S. trade

dispute. In the positive scenario the situation will develop along the path to

normalisation; but in the negative scenario I think recession is more-or-less

unavoidable," another Eurosystem source said.

     "It's more or less clear that, at least end of 2018, the first quarter of

2019, will see some downside surprises. We have already seen some, and there are

probably more in the pipeline. At least in the short-term."

     --INFLATION NOT FIRING

     The failure of wage increases to fuel inflation is increasingly a concern,

the source said: "The traditional textbook also says it takes six to twelve

months for that transmission to occur. I think in general the theory is probably

still valid, but we are seeing long lags and remain vulnerable to any new

downside surprises."

     Only "something catastrophic" could prompt the ECB to backtrack on its

decision to end its net bond purchases in December, the source said.

     Any tightening effect from the ECB's withdrawal from asset purchases is

being mitigated by its continuing commitment to continue to reinvest bonds

maturing from its existing stock for an extended period of time past the first

interest rates rise.

     Such reinvestments are very likely to go on for as long as three years,

said two Eurosystem sources.

     The ECB will also consider a fresh round of cheap funding for banks under

its targetted longer-term refinancing operations programme. While not all in the

ECB are convinced of the need for a fresh round of the loans, they are aware

that some banks, particularly in Italy, may find it harder to meet their net

stable funding requirement ratios under Basel III rules once existing TLTROs

begin to cease to be counted as of mid-year.

     "A lot depends in Italy on TLTROs, and the banks are indirectly financing a

large stock of government bonds using this source. It will be a tough decision

[whether or not to reintroduce them]," one source said. Another added: "We will

want to avoid giving the impression that we are doing it just because some banks

want it or need it."

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

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