Thursday, March 5, 2015

Good news show from Nikosia

As expected, the ECB today kept interest rates unchanged at its meeting in Cyprus. While Draghi was surprisingly upbeat on the economic outlook and the impact of QE, he kept a stringent stance on Greece. The ECB’s macro-economic assessment sounded as if the ECB is a bit inebriated by its own QE announcement. It was the most positive and optimistic assessment in a long while. Words like “broadening” and “strengthening” had not been used in combination with the Eurozone recovery for quite a while. In more detail, the ECB emphasized a “significant number of positive effects” from latest monetary policy decisions, as for example improved financial market conditions, financing conditions and lower borrowing costs. Moreover, the ECB stressed the fact that confidence indicators had also improved recently. Finally, lower energy prices and the weaker euro exchange rate should also contribute to the Eurozone recovery. This more positive take on the Eurozone economy was also reflected in the latest ECB staff projections which foresee GDP growth coming in at 1.5% in 2015 (from 1.0% at the December projections), 1.9% in 2016 (from 1.5) and 2.1% in 2017. It was for the first time since 2007 that the ECB projects a single year with GDP growth above 2%. With regards to inflation, ECB staff revised downwards its projections for this year due to lower actual inflation rates. More generally speaking, the ECB expects a very gradual increase of inflation over the coming years. In detail, ECB staff projections now foresee headline inflation to come in at 0% this year (from 0.7%), 1.5% in 2016 (from 1.3%) and 1.8% in 2017. To be fair, Draghi said that the ECB’s staff projections were conditional of a full implementation of all announced monetary policy measures. Don’t even dare thinking about tapering before QE has actually started. As for QE, Draghi revealed some interesting details. The ECB will start the actual government bond purchases next week Monday. Draghi repeated the January wording that the ECB will buy 60bn euro per month until the end of September 2016 and, in any case, until the ECB sees “a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2%”. The latter gives the ECB a lot discretionary power to alter the programme if need be. Draghi explicitly said that the ECB would buy government bonds with negative yields only if yield are not lower than the deposit rate. This would currently only exclude 2 year German government bonds. During the press conference, there were also several questions on Greece, QE and ELA. The bottom line of Draghi’s answers was that the ECB would only buy government bonds rated lower than investment grade if the countries are in a bailout programme and the programme is not in a review period. Moreover, the ECB could not buy more than 33% of a single issuer. For Greece, all of this means that the ECB could at the earliest start purchasing Greek bonds only in June or July, if and when Greece has reimbursed the bond expiring in June which the ECB had (partly) purchased under the old SMP programme. Finally, Draghi also said that ELA for Greek banks had been extended by 500 million euro. The ECB’s stance on Greece has definitely not softened. Overall, the ECB’s macro-economic assessment was much more upbeat than in previous months. It looks as if at least the ECB is a strong believer in the positive economic impact of its own QE programme. Admittedly, it would have been difficult for the ECB not to be positive but today’s euphoria was in our view almost a bit overdone. The warning that the more positive outlook should not lead to complacency and that now governments had to “contribute decisively” to the recovery was a standard part of the ECB’s introductory statement. However, it remains to be seen how credible this call on governments will be if at the same time the ECB will make an enormous advance payment in the form of its QE. To some extent this has some similarities with parents cleaning up their children's room and then asking them to do something as well. A strategy that might not make it into bestselling parenting guidebooks.

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