Still stuck on central-bank life support


Five years after the onset of the global financial crisis, the world economy is in such a chronic condition that the European Central Bank might cut interest rates this week and the Federal Reserve is likely to indicate no let-up in the stimulus it is providing the U.S. economy.

With the euro zone economy in recession, momentum is building for the ECB to lower interest rates for the first time since July 2012, according to senior sources involved in the deliberations.

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If the bank does not act on Thursday, a quarter-point cut in June is considered a racing certainty.

The ECB is the most conservative of the world's main central banks. Its main short-term rate, now at 0.75 percent, is higher than the equivalent rate of the Fed, the Bank of England and the Bank of Japan. And unlike its peers the ECB has not engaged in quantitative easing - printing new money to buy bonds.

But the ECB seems to be softening. "I would argue that the ECB should be thinking of easing policy; whether they are currently is more debatable," said Stephen King, global chief economist for HSBC in London.

Only a small majority of 76 economists polled by Reuters expected a cut as early as this week.

The swing factor for King is what is happening to Germany, the euro zone's largest economy. Until recently, Germany had been showing resilience thanks to its export sector. But April's survey of purchasing managers and the Munich IFO institute's monthly poll were distinctly soft.

"Germany is becoming more like everybody else. It is being dragged down, whether it likes it or not, through weakness in southern Europe, slowing growth in China and the depreciation of the Japanese yen," he said.

"None of these things are good for Germany. So the weaker Germany becomes, the easier it is to agree on a common monetary policy," he added.

China's official purchasing managers' survey for April, to be released on Wednesday, is likely to provide more evidence that the world's second-largest economy is shifting down to a lower trend rate of growth after three decades of averaging around 10 percent a year.

Economists polled by Reuters expect the index derived from the survey to have edged up to 51.0 from 50.9 in March, holding above the threshold of 50 that demarcates month-on-month expansion from contraction.

Jian Chang, who tracks the Chinese economy for Barclays in Hong Kong, prefers to describe the economy as being in a stabilisation rather than a recovery phase.

"As long as the PMI comes in above 50 it will show that modest, slow growth is continuing," she said.

Global markets have become addicted to the drug of super-fast Chinese growth and tend to react badly to signs of softness. But Chang said the authorities in Beijing, intent on guiding the economy to a more sustainable growth rate, are not panicking.

There has been no big investment package, for example, to support the government's urbanization drive.

Policymakers will be comfortable as long as growth for the year as a whole comes in above their target of 7.5 percent, she said. Barclays is forecasting an outcome of 7.9 percent.

Whether that target is met will depend in part on an improvement in exports to the European Union and to the United States, which on Friday reported a disappointingly soft first-quarter gross domestic product growth rate of 2.5 percent.

The pace of expansion has averaged just 1.4 percent over the last two quarters and 1.8 percent over the past year, noted Jay Feldman, director of U.S. economic research at Credit Suisse in New York.

"All in all, growth is persistent, but decidedly underwhelming. At this trajectory, achieving a labor market recovery beyond the fits-and-starts progress of the last few years will be a challenge," he told clients.

Figures this week are likely to fit into the same pattern.

The Institute of Supply Management's April manufacturing survey is forecast to dip to 51.0 from 51.3 in March, while the economy is likely to have generated 150,000 jobs in April, up from just 88,000 in March but not enough to reduce the jobless rate from 7.6 percent.

Because the Fed has pledged to stick to its super-loose policy until unemployment falls to 6.5 percent, the central bank is expected to confirm at this week's policy meeting that it will keep buying $85 billion in bonds every month to keep bond yields low and encourage investment.

Talk had started to grow that the Fed might start to wind down, or taper its quantitative easing program. But after the latest economic data, the central bank's tone is likely to change, according to Steve Ricchiuto, chief U.S. economist for Mizuho Securities in New York.

"They're going to come out of this meeting with a more balanced view on tapering and say, ���we could increase or we could taper'," he said.

Indeed, price pressures are so muted because of slack in the economy that some Fed policymakers have raised the prospect of injecting even more stimulus.

The core personal consumption expenditure deflator, the Fed's favorite inflation gauge, rose just 1.3 percent in the year to March, Friday's GDP report showed.

"Low inflation leaves that much more leeway for the Fed to focus on growth and jobs. If the core PCE index falls much farther, look for ���inflation being too low' to show up in more Fed communications," Feldman said.

(Editing by Greg Mahlich)