As expected, the ECB kept interest rates on hold. ECB president Draghi successfully tried to talk down the euro exchange rate and opened the door for possible policy action.
As regards the macro-economic assessment, the ECB’s view remained broadly unchanged. The weakness of the Eurozone economy at the end of last year and beginning of this year is still acknowledged. The economy is still expected to recovery gradually in the second half of the year. Nevertheless, risks to the economic outlook are still to the downside. As regards inflation, the ECB continues to see risks to the outlook for price developments to be broadly balanced. However, the ECB now expects headline inflation rate to drop below 2% somewhat earlier than last month. Interestingly, ECB president Draghi added a new downside risk for price stability: the appreciation of the euro exchange rate.
Ahead of today’s meeting, market participants had been focussing on two special topics: the latest appreciation of the euro exchange rate and recent comment by French president Hollande and last night’s decision by the Irish government to liquidate the Anglo Irish Bank. As regards the Irish decision, it seems as if the ECB wants to buy time. According to Draghi, the ECB only took note of the Irish decision but did not decide on how it would treat any replacement of the promissory note with a basket of bonds.
The stronger euro had been the hot topic in financial markets during the last days and weeks. French president Hollande had added oil to the fire earlier this week, calling for a more active and common exchange rate policy. Draghi countered the issue elegantly. Contrary to his predecessor, Draghi did not strike a full blow towards politicians but just stressed the ECB’s independence. Rightly so. In fact, while the European Treaties give politicians the right to come up with “general orientations” for exchange rate policy, these orientations cannot bind the ECB if it considers them to be inconsistent with price stability. Moreover, the Treaties prohibit the ECB to take instructions from governments.
Draghi’s biggest challenge was to show his magic skills of verbal interventions and to talk down the euro exchange rate. He succeeded. Adding the stronger euro to the downside risks for price stability opened the door for new policy action if the euro strengthens further and starts to weigh on the growth and inflation projections. Moreover, Draghi did not get tired of stressing the ECB’s accommodative monetary stance. He even implicitly voiced his dissent with monetary policies too obviously aimed at weakening the currency, sending an implicit signal that the ECB would not be happy with a further, not fundamentally-driven, appreciation of the euro.
At least for now, it is mission accomplished. Mario Draghi is on the best way to become the new central bank Maestro, being able to talk the talk without having to walk the walk.