‘ECB rate cut into negative territory may be required’

The ECB could be forced to introduce another long- term refinancing operation and drag the deposit rate into a negative territory to cushion the region from another year of sluggish growth and the uncertainty caused by the comprehensive assessment of the banks, according to the Bank of America Merrill Lynch 2014 economic outlook.

Overall, the investment bank is bullish on the prospects for the global economy. For the first time in five years, Bank of America Merrill Lynch does not see any major threat to growth. The US has the potential to surprise on the upside, while some emerging markets could post above forecast growth.

The eurozone remains the laggard. The increasingly benign international backdrop will act as a bulwark against the eurozone from slipping into a debt-deflationary spiral.

However, policy errors, particularly forcing periphery countries into massive fiscal consolidation in the teeth of a biting recession, has meant that the region is well below its growth potential. Growth is forecast at 0.8% in 2014 and 1.5% in 2015.

The authors of the report note that the ECB might have to look at a long-term refinancing operation with a maturity of longer than one year in order to smooth off possible turbulence in the financial markets.

Moreover, the failure to tackle the banking problems could result in prolonging the credit drought in the periphery.

One of the three main risks to the eurozone are growth coming in lower than forecasts.

Another threat would be the return of austerity. Amid continued high public debt, the new European Commission — expected to take office late in 2014 — could see the 2015 return of growth as an opportunity to resume fiscal adjustment.

A return to austerity in 2015 could not only jeopardise the recovery of economic growth, but more worryingly also that of inflation.

Only in a few instances have European governments respected their fiscal framework, and politics have frequently undermined it to preserve growth.

The third risk is political instability. The upcoming European Parliament elections provide a platform for eurosceptics to make gains at the expense of pro-European parties.