Thursday, April 3, 2014

ECB meeting - The art of doing nothing

As expected, the ECB kept its ammunition dry. Rates were left unchanged but ECB president Mario Draghi sharpened up the ECB’s language to again stress its determination to act (if needed). The ECB’s macro-economic assessment was almost a verbatim copy of last month’s. Economic activity is bang in line with the ECB’s base case scenario. The gradual recovery should continue, although the ECB still sees downside risks to the economic outlook. Interestingly, the exchange rate was still not mentioned as one of these downside risks. As regards inflation, ECB president Draghi remarked that he had been surprised by the March drop in headline inflation. However, contrary to the inflation data ahead of the November rate cut, the March inflation surprise would not have any significant impact on the ECB’s inflation outlook. In the ECB’s view, the timing of Eastern should push up inflation in April and the base case scenario of a gradually accelerating inflation rate until the end of 2016 remains unchanged. Risks to this scenario are still balanced but, remarkably, the exchange rate was explicitly mentioned as a risk factor. During the Q&A session, it became also clear that the ECB is not so much concerned about deflation but rather of a prolonged period of a very low inflation. In the absence of any real action, the ECB provided markets with the expected verbal action. One entire paragraph in the ECB’s introductory statement was dedicated to stress the ECB’s determination to act. “We are resolute in our determination to maintain a high degree of monetary accommodation and to act swiftly if required. Hence, we do not exclude further monetary policy easing and we firmly reiterate that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time…The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.” There are clearly two key take-aways from this sharpened language: i) the ECB is on even higher alert than before; and ii) unconventional measures, including the for markets so important QE, are backed by all ECB members. Listening to Draghi during the press conference and looking at the available options, however, still leaves us with the impression that QE will not happen any time soon. Draghi’s reference to the Fed and the totally different institutional set-up in the US and the Eurozone indicated that any Fed-style QE, which bypasses banks, is highly unlikely. Interestingly, given his comments it looks as if the option of a negative deposit rate currently has fallen into the category of unconventional measures. For the time being, the ECB sees low inflation as the result of positive supply shocks and temporary factors. In fact, the current period can still be filed under Draghi’s earlier label “with low inflation, you can buy more stuff”. However, today’s press conference signalled that the ECB has increased its state of high alert. Given the expected reversed Easter bunny effect on prices next month, it looks unlikely that the ECB will act at its May meeting. The June meeting, with the next round of ECB staff projections, should be the ultimate litmus test for the ECB’s sharpened determination. If then the 2016 inflation outlook shows lower numbers than the current 1.5%, new ECB action looks probable. This does not necessarily have to be QE. Draghi’s comment that the ECB had not yet reached the end of its conventional measures indicates that a refi rate without a negative deposit rate cannot be excluded. All in all, the bottom line of today’s ECB meeting is that the famous “we stand ready to act” has been stretched to its maximum. No further verbal stepping up possible. The ECB seems to be well aware of the downside risks and implementation difficulties surrounding unconventional measures. Still, the ECB mentioned them to maintain its own credibility. The risk of this strategy can be found back in Goethe’s The Sorcerer’s Apprentice. “beware of the spirits that you call ”. From here on, a further verbal stepping up seems impossible. In a way it’s a gamble, either the recovery continues and inflation picks up again, or the ECB will have to act in June, even if it’s only a small refi rate cut. Carsten Brzeski

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