LONDON, July 14 (Reuters Breakingviews) - The European Central Bank is dipping its toe into potentially inviting waters. President Christine Lagarde on Wednesday took the first step towards a digital euro by launching a two-year investigation into the possibility of issuing an electronic currency. Despite the abundance of caution, the ECB has reason to leapfrog the Federal Reserve. Neither central bank is interested in keeping up with the People’s Bank of China, which has already trialled a digital yuan in major cities including Shenzhen and Shanghai. But Covid-19 has accelerated the demise of physical cash: Nearly nine of out 10 people said they would either certainly or probably pay less with cash after the pandemic, an ECB survey of euro zone citizens showed last year. A key issue for Lagarde and her peers will be whether digital cash issued by the central bank leaches too many deposits from commercial banks, which are vital for channelling credit to households and businesses. A UBS survey of central bank reserve managers found the most-cited potential threat was that digital coins could lead to banks being disintermediated, which might upset financial stability. That would have particularly negative economic consequences in Europe. As Morgan Stanley economists point out, the region’s banks provide three-quarters of firms’ financing needs; in the United States, the same proportion of corporate financing comes from capital markets. But there are ways around this problem, such as setting a maximum amount that any household could hold in digital euros. And there are potentially big advantages for the ECB, which has struggled more than the Fed to generate enough inflation over the past decade. An e-euro could be designed to allow the central bank to impose negative interest rates directly on households, rather than relying on commercial banks to pass on the effects of monetary easing. This would make its policies far more powerful: though the ECB currently charges minus-0.5% on deposits at the central bank, commercial lenders have mostly avoided passing on those rates to clients, except for very large deposits. And if enough citizens owned a digital wallet, governments could make direct fiscal transfers to stimulate the economy during downturns. Given sluggish growth and disinflation have been more of a problem for the euro zone than the United States, the ECB has extra reasons to make the digital leap. Follow @swahapattanaik on Twitter CONTEXT NEWS - The European Central Bank on July 14 gave the green light to a process which could eventually lead to launching a digital version of the euro. - The ECB formally approved what it called the “investigation phase” which will last two years and aim to address key issues regarding design and distribution of the digital currency. The work will not prejudge any future decision on the possible issuance of a digital euro, which will come later, the ECB said, adding that in any event a digital euro would complement cash rather than replacing it.