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ECB Leaves Policy Mix Unchanged as It Monitors Covid-19’s Impact

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FRANKFURT—The European Central Bank left its large monetary stimulus unchanged Thursday, as policy makers wait to see how a resurgence in Covid-19 cases across the continent and a jump in the value of the euro might affect the region’s economy.

ECB President Christine Lagarde said the bank is paying close attention to the currency, highlighting its recent gains against the dollar and others as a drag on inflation, and adding that the eurozone economy is experiencing a strong rebound from its sharp contraction.

“Looking ahead, a further sustained recovery remains highly dependent on the evolution of the pandemic and the success of containment policies,” she said after the policy decision was announced.

Europe’s economic recovery has lost momentum in recent weeks after an initial strong bounce back, and ECB officials are worried about a possible wave of job cuts and corporate bankruptcies later in the year as some state subsidies are wound down.

Many analysts expect the bank to scale up its monetary stimulus by December, especially after Federal Reserve Chairman Jerome Powell signaled last month that he is willing to allow inflation to run hotter than usual to support the labor market, a major policy shift that suggests the U.S. central bank will keep interest rates low for years. That puts pressure on the ECB to follow suit.

The ECB said in a statement that it would leave its key interest rate unchanged at minus 0.5% and continue to purchase up to 1.35 trillion euros, equivalent to $1.59 trillion, of eurozone debt under an emergency bond-buying program unveiled in March.

The eurozone economy has been less damaged by government-imposed lockdowns and actions taken by individuals to avoid infection than the ECB had feared. The ECB’s economists Thursday said they now expect the eurozone’s economy to shrink 8% in 2020, having forecast a decline in output of 8.7% in June.

However, recent economic data suggest that confidence among the region’s consumers and businesses is starting to wane, even though economic activity remains as much as 10% below its level at the start of the year.

“Recently, momentum has slowed in the services sector,” Ms. Lagarde said.

In a red flag for the ECB, the region’s inflation rate plunged to minus 0.2% in August, far from the bank’s medium-term target of just below 2%.

Virus cases are surging in France and Spain, raising fears of a powerful second wave in the winter months that could trigger fresh social restrictions and hurt consumer and business confidence.

Europe’s state support programs have so far helped to keep unemployment low compared with the U.S., and businesses afloat. But some of those could soon be phased out as governments start to worry about their enormous cost.

Meanwhile, the euro has appreciated by more than 10% against the dollar in recent months, to around $1.18. That partly reflects investors’ confidence in Europe’s economic recovery and its powerful policy response to the pandemic.

Economists have long used letters of the alphabet like V and U to describe economic recoveries. But the coronavirus downturn is so different from past recessions that economists are coming up with new shapes to describe the potential recovery. WSJ explains. Illustration: Jacob Reynolds

But a stronger euro also tends to hurt the region’s large exporters by making their products more expensive in international markets. That hurts growth. Exporters are also wrestling with disruptions to their global supply chains, ongoing trade conflicts and uncertainty around the European Union’s future relationship with the U.K. after Brexit.

“Given that recoveries in the eurozone are often kick-started by net exports, a stronger euro could hamper any recovery going into the second half of the year and beyond,” said Carsten Brzeski, an economist with ING Bank in Frankfurt.

Ms. Lagarde said ECB officials had extensively discussed the currency’s recent gains, which she said would weigh on an inflation rate that is set to remain negative over the coming months.

“The Governing Council will carefully assess incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook,” she said.

To address those economic threats, most analysts expect the ECB to scale up its €1.35 trillion bond-buying program by the end of the year, perhaps by €500 billion. Such a move, which aims to lower borrowing costs and support growth, would appear premature this month because the ECB has only spent about €500 billion of the total so far.

Some analysts also expect the ECB to cut its key interest rate further below zero, a move that could weaken the euro currency but might also hurt the region’s banks.

Write to Tom Fairless at tom.fairless@wsj.com

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