It is open hunting season on the euro as ECB hits the panic button on rates

The European Central Bank is running scared and in policy disarray. Euro zone interest rates have been cut deeper into negative territory, the QE programme has been stepped up and the banking system has been flooded with a lot more liquidity. The only unsaid ECB goal is a default target of a weaker euro to help spur faster economic recovery ahead.

The March monetary policy decision reveals the ECB in full retreat. The latest policy manoeuvres are nothing more than a rear-guard action in the face of failing policy, slowing growth and increased deflation risks. The ECB has had to slash its future growth expectations, to levels which still seem far too optimistic given the spectre of a global hard landing.

The main reason why the ECB has hit the panic button is that euro zone inflation is back in negative territory again, with the headline rate dropping back down to -0.2 per cent in the latest month. The ECB has its back to the wall and clearly deeply worried about second round effects on the economy, especially the risk that demand takes another steep nose-dive.

Clearly, the euro zone is still in the grip of aftershocks from the global financial crisis. Years of debt deflation, balance sheet-deleveraging, fiscal austerity and deep-rooted market turmoil are still taking their toll on confidence. Consumers, businesses and governments are still extremely dispirited and need a lot more than gentle persuasion to be coaxed into full recovery.

The big question now is whether the cut in the ECB deposit rate to -0.4 per cent, the 20 billion euro step-up in monthly QE purchases to 80 billion euros and the extra flood of market cash provisions will be enough to turn the tide. Given the prevailing sense of gloom in recent euro zone economic confidence surveys, it suggests a lot more needs to be done.

The ECB could be stuck with near-zero interest rates for another decade. This is no surprise considering the two-decades of recession-buffeted, deflation-bound and ultra-low interest rate afflicted woes that Japan has suffered. The euro zone is in crisis and the ECB is flying blind on policy, with no clear sense of when normal service will be resumed. Anything is possible right now.

The financial wealth destruction to Europe’s consumer, investment, banking and state sectors has been so severe in the last seven years that the yawning demand gap has had to be filled by European tax-payers and the ECB. The process of repair-work could take years to complete leaving the ECB stuck with unconventional monetary responses for decades to come.

Euro zone economic regeneration is not just going to be about Germany regaining a firmer footing over the future, but securing sustainable recovery for all, with inflation coming back to target close to 2 per cent again. It means the scourge of high unemployment in the distressed southern European nations must be quickly addressed.

Expansive deficit spending initiatives are vital to complement the ECB’s monetary stimulus. Without it, the chances of a future euro zone break up run a much higher risk.

By no means is this the last of the ECB’s rate cuts. The loss of momentum in the global economy and the slowdown risks haunting the euro zone suggest there will be more cuts to come. This will continue to put more pressure on the currency over the future, an end-result which the ECB wants and needs to jump-start faster export-led growth.

ECB President Mario Draghi has tried to draw a line in the sand to no more easing, but he still has an unfilled pledge ‘to do what it takes’ to resurrect recovery and meet the ECB’s 2 per cent inflation target over the long term. Right now there is no end in sight to the run-down in euro zone official rates. The risk of recession and the embedded threat of deflation could easily take the deposit rate down towards -1 per cent later this year.

The vultures continue to circle over the euro and the spectre of a return to parity with the US dollar still beckons. With the ECB adding its own seal of approval for a weaker currency to speed recovery through negative interest rates, the euro’s fate is set in stone.

Rising political discord, the deteriorating economic outlook and the ECB pulling out all the monetary stops underlines a treacherous future for Europe’s single currency.