The ECB is eventually expected to embark on outright quantitative easing. HSBC Bank has set a number of signposts which could send the ECB down an alternative route.

The eurozone is still a region struggling with too much debt, too little growth, a strong currency and the threat of Japan-style deflation. This explains why the European Central Bank is still adding monetary stimulus at a time when two of the world’s major central banks are moving closer to the exit.

Financial markets are still digesting the impact of the raft of easing measures delivered by the ECB at the June meeting. The negative deposit rate has so far had little or no downward impact on the euro and the effects of the potentially more powerful measure – the targeted long-term refinancing operations (TLTROs) – will only become apparent in the next 6-12 months. Meanwhile the eurozone survey and activity data have failed to impress and inflation has continued to surprise on the downside. Hence investors still believe that there will be more stimulus to come: purchases of asset-backed securities but also unsterilised purchases of government bonds, ie outright quantitative easing (QE).

QE has been our central view for about a year and remains so. However, it is increasingly becoming a consensus view and it is worth considering what might rule it out. Hence we set out a number of signposts which would reinforce the view that QE is still on the cards or which could take the ECB down an alternative route.

Our inflation projections for 2014-2015, at 0.6 per cent and 0.8 per cent, remain below those of the ECB staff, and the longer inflation stays so low, the greater the risk that it feeds into inflation expectations. We fear that such a low inflation outlook will continue to encourage cash-piling, delay investment decisions, curb hiring and lower potential growth – not only because of a shrinking capital stock, but because savings will increasingly be channelled into government financing given that public sector debt stocks are set to remain very high against a backdrop of such weak nominal growth.

While the ECB stopped short of announcing outright asset purchases in June, it has taken a step closer by suspending sterilisation of the government bond purchases it made under the Securities Markets Programme (SMP) in 2010-2011. The ECB also continues to leave the door open for large-scale purchases “when the inflation data warrant it”. We believe purchases of ABS could happen before end-year, but that full-blown QE would be more a 2015 story and only after projections for medium-term inflation have been lowered considerably and assuming there has been little or no pick-up in loan growth. The 2016 inflation forecast would probably need to be 1 per cent or less.

A QE policy may not be as effective as hoped, but it at least holds out the prospect of weakening the euro and influencing inflation expectations, as long as it is framed in careful communication. It is also not without risks.

Now that an expectation of QE is becoming increasingly priced into markets, the stakes could be high if the ECB fails to deliver. The expectation of eventual ECB asset purchases has played a key role not just in driving down peripheral bond yields but in driving the whole global hunt for yield. Hence it is worth considering what economic events could take the ECB down a different policy track.

Some of the alternative scenarios are positive for the real economy. If the policies already announced have the intended effect, allowing credit growth to recover, wages to revive and investment growth to return, then the ECB forecasts for growth and inflation would remain on track and no further aggressive easing would be delivered.

The support could also be delivered externally. For instance, should 2014 finally be the year that US companies start to spend the glut of cash on their balance sheets and deliver the long-anticipated strong investment recovery, this could drive a much stronger than expected acceleration in US GDP growth, supporting a stronger expansion in world trade and therefore eurozone exports, quite possibly with an added kicker of a weaker currency as the market finally drives the dollar up.

In an environment of unresolved tensions between Russia and Ukraine and the ongoing conflict in Iraq, the prospect of an energy supply shock has reared its ugly head. In this low-inflation world the main impact of rising energy prices will be to hit growth as households’ real disposable incomes and corporate profitability are squeezed, but even a temporary rise in headline inflation to around the 2 per cent level could at least delay further stimulus.

While we believe the ECB would be willing to embark on buying government bonds for monetary policy reasons if it is in danger of missing its price stability mandate, we think it would be difficult to do so if some large member states were relying on such a policy to fund larger budget deficits.

The full report including key European forecasts and statistics is available at www.research.hsbc.com