Thursday, March 7, 2013

ECB meeting – Draghi’s elegant interpretation of “we-never-pre-commit”

As expected, the ECB kept interest rates on hold. ECB president Draghi elegantly balanced between dovish and hawkish comments, keeping all options open. In our view, rates should remain on hold unless the economic recovery fails to materialise in the coming months. Non-standard measures remain the ECB’s most preferred policy option.

The ECB’s macro-economic assessment remained broadly unchanged compared with the February meeting. The ECB still witnesses a stabilisation of the Eurozone economy at a very low level and expects a gradual recovery in the second half of the year. ECB president Draghi stressed the current dichotomy between stabilising and even improving soft data on the one hand and disappointing hard data on the other hand.

The ECB’s macro-economic assessment was also reflected in the latest ECB’s staff projections. In these projections, GDP growth forecasts for both 2013 and 2014 were slightly revised downwards. The new mid-point projection is now -0.5% for 2013 (from -0.3% in the December projections) and 1% for 2014 (from 1.2%). As regards inflation, the projections for 2013 remained unchanged at 1.6% but were slightly revised downwards to 1.3% for 2014 (from 1.4%). These changes were mainly driven by the negative carry-over effect from weaker-than-expected GDP growth in 4Q12 and lower headline inflation rates at the beginning of the year. Broadly speaking, the underlying pattern of the future path of the Eurozone economy has remained unchanged since the December meeting. It looks as if it would need at least one or two months of disappointing hard data before the ECB would change its view.

With the almost unchanged macro-economic assessment, it did not come as a surprise that the ECB kept its risk analysis unchanged. Risks to the economic outlook are still to the downside, while risks to the inflation outlook remain balanced. Notably, the euro exchange rate has disappeared as a downside risk to inflation. Maybe a nice side-effect of the Italian elections and possibly signalling that the ECB is happy with the euro at 1.30 against the dollar.

Sluggish credit growth and, more particularly, the fragmentation of credit growth and credit access for SMEs seems to have become the biggest concern of the ECB. In fact, the Eurozone remains stuck in a double credit whammy, with both the supply and demand side being significantly suppressed. However, the ECB does not seem to have a plan how to tackle this problem.

Ahead of today’s meeting, there was some excitement in financial markets about the ECB’s possible reaction to the Italian elections and the lagging economic recovery. Draghi’s reaction to the Italian elections could become another magic wording. He called it the “angst of the week”. Fiscal reforms in Italy were on auto-pilot and would continue, according to Draghi. Moreover, he reiterated that the rules of the OMT were clear: first a bailout (light or fully-fledged) and then the ECB could consider starting OMT.

While Draghi stubbornly tried to present his fair weather face regarding the economic outlook and the return of growth in the second half of the year, his between-the-lines comments were rather dovish. The introductory statement had the term “accommodative” five times compared with four times in the February statement, Draghi explicitly mentioned that the Governing Council had discussed a rate cut and also said that the “monetary policy stance will remain accommodative as long as needed”. Obviously, the ECB still does not pre-commit in any way but the last statement comes already very close to the Fed’s “rates will remain very low until late 2014”.

All in all, Mario Draghi today had a bit for everyone. A bit of dovishness to dampen the exchange rate and a bit of hawkishness and positivity to counter economic doom-thinkers. The door to a rate cut was not opened further, neither was it closed. It has become a revolving door. In fact, Draghi gave an elegant “we-never-pre-commit” show, keeping all options open.

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