MNI INTERVIEW: Trade Retaliation To Make Job Harder For ECB

The European Central Bank would be able to do little to support growth if its worst fears for a trade war with the U.S. are realised, particularly if European Union retaliation pushes up inflation, its former director general of market operations Francesco Papadia told MNI.

"How much can the ECB help with monetary policy if a bad scenario comes? My sense is it will not be able to do much on growth because we are not talking about issues where monetary policy can do much,” Papadia said in an interview. “An easing of monetary policy, i.e. lower rates, is not very effective against trade disruptions."

A potential trade war is likely to be a key consideration at Thursday’s rate-setting meeting as the prospect of EU retaliation grows amid fears over U.S. tariffs following the Aug 1 deadline. (See MNI: Support Grows For Retaliation Against US - EU Officials) 

"So far Europe has been - rightly - very careful regarding retaliation," he said. "But faced with the stubborn American position, it could be that Europe says, 'no, this is too much!' Then the story becomes much more worrying."

Asked about the recent comment by ECB Vice President Luis de Guindos that a euro above EUR1.20 would be problematic for the economy, Papadia noted that the currency's real effective exchange rate has risen less than its level against the dollar. While the disinflationary impact of a strong currency is limited on its own, it comes at a time when subdued wage growth is already containing the rate of increases in prices, he said.

"Euro area wage developments are muted, around 2.5%, so the exchange rate becomes more important because it adds its effect to what is happening with wages,” said Papadia, who left the ECB in 2012 and is now a senior fellow at the Bruegel think tank in Brussels.

While ECB Executive Board Member Isabel Schnabel recently said that the QE bond portfolio should be reduced to zero before the bank started to build a structural bond portfolio for long-term refinancing operations, Papadia said he sees no real need to distinguish between the QE portfolio and any structural portfolio of long-term bonds for refinancing operations. It is accepted within the ECB that its future balance sheet will have a bond component, he added.