ECB's 4th of July tribute: forward guidance

The ECB kept its interest rates on hold. What was expected to be a rather dull meeting, turned out to be historical. With forward guidance for the first time ever and further rate cuts in sight, the ECB tries “whatever-it-takes” to safeguard the fragile recovery of the Eurozone.

As regards the macro-economic assessment, the ECB has again become somewhat more cautious compared with last month. The base case scenario still foresees a gradual recovery of the Eurozone economy in the second half of the year, “albeit at a subdued pace”. However, latest developments in financial markets seems to have created some note of caution as the ECB added a new downside risk to the economic outlook: the “recent tightening of global money and financial market conditions and related uncertainties”. As regards inflation, the ECB still expects underlying price pressure over the medium term to remain subdued. Risks to this outlook remain balanced but the addition of the small word “still”, now reading that “risks to the outlook for price developments are still broadly balanced…” could be an intermediate step towards downside risks.

New additional downside risks to growth and the marginal shift to the downside of inflationary risks has led to an unprecedented step: for the first time ever, the ECB gave forward guidance on its interest rates by saying: “the Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics.” No more “we never pre-commit”.

There had been a lot of speculation ahead of today’s meeting on how much guidance the ECB could give to stress that an exit of loose monetary policy was anything but near and that any Fed tapering should not be extrapolated to the Eurozone. Today’s answer was unexpectedly strong. The fact that ECB president Draghi also mentioned that a rate cut had been discussed at today’s meeting underlines the clear downside bias. According to Draghi, this new forward guidance is conditional to three factors: medium-term inflation outlook, economic growth and monetary aggregates and credit growth. As these three factors are nothing else than the well-known three pillars of the ECB’s monetary policy assessment, there still is ample room of future speculation and interpretations.  The ECB did not (yet) go all the way by linking its forward guidance to specific indicators as the Fed has done.

On a different matter, Draghi remarked that the ECB was not in a leading role any longer on the discussion on how to restart lending to SMEs. According to him, the ECB was now in an advisory role. In our view, a clear sign that any ABS purchases are still unlikely in the near future.

So, what does all of this mean? In our view, the ECB remains highly concerned about the state of the Eurozone economy. In the near term, a rate cut looks like the most likely (and also most easiest) policy option if the economy fails to recover. To get some idea on when the ECB would ever start to exit loose monetary policy, a close look at inflation forecasts and credit growth should currently be the best guide.

Throughout the crisis, the ECB has morphed from a rather hesitant and reluctant into a bold and daring central bank. In fact, over the last months, the ECB has been following the Fed’s footsteps: more focus on growth with explicit mentioning of high unemployment and now the forward guidance. With today’s meeting, ECB president Draghi has again proven that he is the Eurozone’s “whatever-it-takes” man who is willing to let the ECB boldly go where no Eurozone central bank has ever gone before. At least on 4th of July, this unknown place looks a bit American.