Thursday, January 9, 2014

ECB still on red alert

At today’s meeting, the ECB kept interest rates on hold but stepped up its verbal power, stressing its determination to act again. As regards the ECB’s macro-economic assessment, nothing has changed since the December meeting. In fact, it was almost a verbatim copy of the December assessment. The ECB still expects a gradual and weak recovery, with risks surrounding the economic outlook still on the downside. Turning to inflation, the ECB’s assessment also remained unchanged despite the latest drop in headline inflation and the fall of core inflation to an all-time low. According to Draghi, the latest drop was mainly driven by statistical quirks. Risks to the inflation outlook remain balanced. As Draghi put it: “there are limited upside risks and limited downside risks to the inflation path”. Interestingly, the exchange rate was again not mentioned as a risk factor to the economic outlook. During the press conference, Mario Draghi continued to walk on a thin line on the issue of deflation. While the November cut was officially justified by increased deflationary risks for the Eurozone, Draghi today said that there were no risks of deflation, at least not in the textbook meaning of deflation. According to Draghi, even negative inflation rates in some Eurozone countries could not be considered as deflation but were rather the effect of the ongoing structural adjustment. Draghi’s remarks on deflation were on our view remarkable. It looks as if he wanted to guide expectations away from a direct link between lower inflation rates and new ECB action. Looking ahead, the crucial message from today’s meeting was an addition to the introductory statement, reading as “overall, we remain determined to maintain the high degree of monetary accommodation and to take further decisive action if required”. In our view, a clear sign that the ECB is not leaning back to relax but remains on high alert. Despite the ECB’s strong determination, it was striking that Draghi refrained from going into details of possible next steps. Instead of giving a glance of the ECB’s range of instruments, he only said that the ECB would use all instruments eligible under the European Treaties. This leaves enough room for speculations and phantasies. In our view, it looks as if the ECB is trying to build a tailor-made toolbox with different tools for different situations. In our view, there are three main triggers for further ECB action in the coming months: i) unwarranted money market tightening; ii) a faltering of the recovery; and iii) a stronger euro exchange rate. Obviously, these three factors would have a deflationary impact on the Eurozone economy. Tackling these three problems would indeed require different instruments: (conditional) liquidity for the money market, funding for lending and/or QE for the economy and a negative deposit rate for the exchange rate (or a combination of all three). All in all, fears of another surprise step by the ECB at today’s meeting turned out to be unjustified. Instead, the ECB kept at least one good old tradition unharmed: never change rates in January. So far, the ECB only changed its policy rate in January 2009. Looking ahead, today’s meeting confirmed the ECB’s current monetary stance: it’s rather a state of red alert than a traditional wait-and-see.

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