ECB meeting - featuring The Zlack

It must have been a disappointment for those who had expected an exciting and action-loaded ECB meeting today. In fact, the ECB did not do anything. Interest rates remain on hold and any possible new unconventional measures were left safely stored in the closet. ECB president Mario Draghi himself had stirred the expectations for today’s meeting during the press conference back in February. However, looking at the pure economic facts, the ECB did not see any reason to change its current policy stance today. Looking at the economic indicators released since early February could only lead to ticking all the boxes with the name “no change” on it. Confidence indicators increased despite emerging market concerns, inflation stabilised and is – according to the ECB – artificially kept low by negative energy price effects and the appreciation of the euro, and peripheral countries showed further signs of improvement. At the same time, money markets normalised. Only bank lending stagnated, but at least did not get worse. In sum, all incoming data released since February made it very hard to justify further ECB action. The long-awaited ECB staff projection also made it harder to act. In short, the latest ECB staff projections confirmed the well-known baseline scenario of a continuation of the Eurozone’s gradual recovery in the coming years with expected GDP growth rates of 1.2% (from 1.1%), 1.5% (unchanged) and 1.8% in 2014, 2015 and 2016 respectively. As regards inflation, ECB staff expects a slow increase of headline inflation in the years ahead from 1.0% in 2014, to 1.3% in 2015 and 1.5% in 2016 (with 1.7% expected in 4Q). Risks to the economic outlook are still to the downside and balanced for the inflation outlook. The same old story. During the press conference, Mario Draghi continued with its latest efforts to downplay the deflation threat. Remember that back in November, deflation was still the biggest risk for the Eurozone. The tone has changed. We already learned earlier that deflationary forces were (partly) a result of structural adjustment in the Eurozone periphery and that it was needed to look at the individual components of the HICP basket and not at the headline number when measuring deflation. Today, the backtracking received three new elements: slack (also known as The Zlack) in the economy, energy prices and the exchange rate. Obviously, slack in the Eurozone economy will keep inflationary pressure low for several years. According to Draghi, the negative impact from lower energy prices had shaved off 0.5%-points of headline inflation, while the appreciation of the euro accounted for another 0.4%-points. The fact that Draghi explicitly mentioned the exchange rate impact on inflation is in our view a clear signal that the ECB would not be pleased with a further strengthening of the euro. Judging from Draghi’s statements, the ECB’s inaction is the result of better-than-expected data but also of the fact that all potential next steps are either highly complicated to implement or highly controversial; or even both. Over the last month’s, the ECB had often put many market participants off the scent. With today’s meeting, this confusion should hopefully end. New action is still possible but only if tensions in the money market increase and/or the inflation outlook worsens. Until then, the ECB will lean back and do nothing, enjoying what Draghi called the island of stability.