By Francesco Guarascio
BRUSSELS (Reuters) – The euro zone economy faces rising risks stemming from trade tensions, Brexit and Italy, the International Monetary Fund said on Thursday in an annual report, where it also backed the European Central Bank’s (ECB) plans for fresh stimulus.
In the report, its last on the euro zone before the Fund’s managing director Christine Lagarde leaves in November to head the ECB, the IMF said the bank’s plans to keep monetary policy accommodative were “vital” as the currency bloc faces “a prolonged period of anemic growth and inflation”.
The report also said the euro remained slightly undervalued despite having appreciated last year, confirming a Reuters report last month. It urged countries with large trade surpluses, including Germany and the Netherlands, to invest more to help rebalance the exchange rate.
Output growth in the 19-nation currency bloc will slow to 1.3% this year from 1.9% in 2018, the Fund said, rebounding to 1.6% in 2020.
The IMF’s forecasts were slightly better than those released on Wednesday by the European Commission, the EU’s executive arm, which saw euro zone growth at 1.2% this year and 1.4% in 2020.
However, the Washington-based Fund sees growing risks from global trade tensions, uncertainty caused by Britain’s unclear path to leave the EU and Italy’s vulnerability caused by its high debt, of which a large portion is held by domestic banks.
Although yields on Italy’s bonds have recently fallen, the report said, a change in market sentiment could not be ruled out. That could force Italy’s anti-austerity government to adopt a “sharp fiscal tightening” even if growth slows, with risks of spillovers into other euro zone countries, the Fund said, confirming a Reuters report last month.
ECB, PLEASE DON’T TIER
The IMF also predicted inflation to remain far off the ECB’s close-to-2% target at least until 2022, and forecast a 1.3% rate this year, in line with ECB estimates.
“The undershooting of the inflation objective calls for prolonged monetary accommodation,” the Fund said, welcoming the central bank’s plans to maintain its easy-money policy.
The Fund raised doubts about possible plans for a tiered deposit rate, which would lower the charge banks pay on some of their excess cash.
“A regime of tiering (..) would have a very small impact on aggregate bank profitability and a questionable impact on credit conditions,” the report said, adding that the costs of negative rates were likely outweighed by indirect positive effects.
In case of a further worsening of inflation expectations, the IMF said that more accommodation may be necessary, and could include a new asset purchase program.
The new purchases would need to maintain the same distribution across euro zone states and could be broadened to a larger set of eligible assets, the fund said.
Whereas “there may be only limited room to cut rates,” the IMF did not rule out new stimulus measures, “such as new, cheaper liquidity facilities for banks.”
The report said the ECB’s new round of cheap multi-year loans for banks, known as TLTRO 3, was a good move, but said it also risked expanding banks’ exposure to their home country debt.
To prevent this, it said, “it is appropriate for the ECB to shorten the maturity of the new TLTROs and to offer less generous pricing terms than on TLTRO II”.
In its report, the Fund also called for centralized supervision of money-laundering risks at banks in the euro zone, after a string of cases that exposed national shortfalls in countering financial crime.