China Slowdown Has Two 'Substantial' Effects On Global Economy: European Central Bank President Mario Draghi

European Central Bank President Mario Draghi said the central bank is keeping a close eye on China’s slowing economy amid the recent turmoil in global markets. Ahead of the G20 meeting this weekend, China is likely to be a key issue as the ECB is worried a slowdown in the world’s second-largest economy is going to have two detrimental effects on the global economy.

“One is through the trade channel, weakening the economies of the rest of the world ... and the confidence effect on the stock market and all the other financial markets, which is also operating on the negative side,” Draghi said at a press conference Thursday at ECB headquarters in Frankfurt, Germany.

The International Monetary Fund has called on global central banks this year to refrain from tightening policy, fueling fears the world is on the brink of a major downturn. As global markets continue volatile trading this week, economists question whether the U.S. is strong enough to move away from crisis-level interest rates this year.

The ECB dropped a few hints at boosting stimulus sometime soon, which could put added pressure on the U.S. Federal Reserve to hold off on raising rates because if the central bank moves too soon, it would be a more rapid divergence from the ECB’s monetary policy in the midst of the recent turbulence in financial markets, said Dan North, chief economist at Euler Hermes North America.

"The stock market is not a very good predictor of the economy. However, the Fed has their eye out and it could potentially cause problems for global economic growth," North said.

The ECB also cut its inflation and growth forecasts for 2015 and the next two years in the midst of market turmoil over China's slowing economic growth.

“The growth outlook is hardly strong and the concerns over China and the appreciation of the euro present a serious external threat,” Jonathan Loynes, chief European economist at Capital Economics, said in a research note Thursday.

Gus Faucher, senior macro economist at PNC Financial Services Group, agrees. "The European economy is finally starting to turn around, but growth in China is slowing. The stronger dollar will also be a drag, making U.S. exports overseas more expensive, and makes imports into the U.S. less expensive," Faucher said in a note.

The ECB’s decision to leave its policy stance unchanged Thursday was widely expected, but Draghi also provided some dovish signals at the press conference, sending strong indications the ECB’s stimulus program is likely to be extended. Following the announcement, European markets rallied 2 percent while the euro fell to its lowest level against the dollar in two weeks at $1.11.

The central bank said it could increase the "size, composition and duration” of its massive 1 trillion euro ($1.1 trillion) stimulus program beyond next year, which would pave the way for an increase in bond-buying in the coming months.

The central bank is ready to extend quantitative easing (QE) beyond next year “if necessary” until the ECB sees inflation move closer to 2 percent “over the medium term," Draghi said at the press conference. The ECB left benchmark interest rates unchanged Thursday and maintained its QE program at its current level of 60 billion euros ($66.8 billion) a month.

If the ECB adds additional stimulus in the coming months, it will have a significant effect on the euro as the ECB pumps more money into Europe's economy. By increasing the money supply, the ECB will weaken the euro against other major currencies. That will then help boost the continent's exports and inflation. A cheaper euro can boost its economy by making it easier for it to sell goods to other countries.

The QE program includes buying government bonds in order to push down their yields. With interest rates at record lows, investors are looking to move cash overseas into places such as the United States, where they are likely to get a better return. As money flows out of Europe, the euro is depreciating.

The European Central Bank launched its QE program in March, with expectations to end it in September 2016. The effort will pump 1 trillion euros into Europe’s economy, meaning 60 billion euros will be injected each month for 18 months -- from March 2015 to September 2016 -- in an effort to restore the inflation rate to a targeted level of 2 percent and help boost economic growth in the troubled region.

The latest news on the eurozone economy has been reasonably upbeat, with surveys such as August’s final Purchasing Managers Index pointing to a possible slight re-acceleration in gross domestic product growth in the third quarter.

Eurozone business activity accelerated at its fastest pace in more than four years last month, as Markit's final August Composite Purchasing Managers' Index came in at 54.3, beating an initial estimate of 54.1.

Meanwhile, the Greek crisis has clearly eased somewhat after the approval of the third bailout.

The ECB now forecast eurozone economic growth of 1.4 percent in 2015, compared with its previous projection of 1.5 percent. The central bank also cut its growth forecasts for next year, lowering expectations to 1.7 percent in 2016, down from a previous projection of 1.9 percent.

The ECB kept its main interest rate on hold at 0.05 percent.

Inflation remains uncomfortably close to zero and may well drop below it again in the coming months if oil prices remain at current levels. While this may provide an additional short-term boost to consumer spending, it also may raise the risk of a renewed fall in inflation expectations, Loynes said.

Draghi said inflation is rising slower than previous expectations, and that negative inflation is possible in coming months. Annual inflation was 0.2 percent last month, far below the ECB’s target near 2 percent, the European Union’s statistics office in Luxembourg said in a report issued Monday.

“The strong message is that the ECB is ready and prepared to increase its policy support for the eurozone economy in the near future,” Loynes said, adding that it’s increasingly likely the pace of asset purchases will be increased at the ECB’s next meeting on Oct. 21-22.