Return of the undercover hawk

As widely expected, the ECB today decided to keep interest rates on hold. It is obvious that in the current rather deflationary environment, rate hikes are only a scenario for the far-off future. In the Q&A session, all questions were once again related to Greece. Trichet did nothing to evoke new speculation about possible ECB steps. To the contrary, in what could be seen as an attempt to escape the Greek crisis, the ECB has secretly become more hawkish.

For the first time in a long while, at least the text of the ECB’s economic assessment was changed. On substance, the main message is still the same: the recovery of the Eurozone economy is continuing. However, there were some interesting changes to the ECB’s take on inflation.

According to the ECB, real GDP is expected to expand at a moderate pace and risks remain balanced. Greatest downward risks stem from the financial crisis, balance sheet adjustments and the labour market. As regards inflation, the ECB introduced a new distinction between global and domestic inflationary pressures. While global inflationary pressures might increase due to energy prices and emerging market inflation, domestic inflation in the Eurozone is expected to remain contained. Inflation expectations remain firmly anchored but the risks are only “still” remaining broadly balanced. In addition, two important sentences have been added to the ECB’s introductory statement: “The firm anchoring of inflation expectations remains of the essence. Monetary policy will do all that is necessary to maintain price stability in the euro area over the medium term”. In normal times, this would have marked a turning point towards a more hawkish stance. However, these are no normal times.

As expected, the Q&A session was only about Greece. Prior to the meeting, there had been plenty of market rumours and advice about the ECB could or should do in reaction to the Greek crisis. Several observers even proposed to ultimately purchase government bonds. Just looking at the facts, the ECB still owns the same toolbox as in the past. Theoretically, it could restart FX swap lines, renew one-year LTOs or extending full allotment procedures at its refinancing operations. A more radical move would be to purchase government bonds in the secondary market. However, such a step would be very controversial to say the least. In today’s press conference, Trichet did not give any hints that the ECB would soon be willing to go beyond last Sunday’s decision when they announced to accept Greek debt as collateral no matter what its rating is.

All in all, the ECB tried to say as little as possible on Greece and possible future action. Maybe this was the lesson from the last weeks and months when several u-turns and unfortunate communication had not done the ECB’s credibility any good. With significant deflationary pressure still looming from future fiscal consolidation, the ECB’s more hawkish tone was probably a bit exaggerated. However, it was an attempt to return focus back to what the ECB is best at: conducting monetary policy.