ECB awaits clear evidence of ‘Brexit’ effects but pleased with market resilience

Draghi careful to keep options open while highlighting downside risks

Weak upcoming survey data would increase expectations of September easing

No pointers as to how to overcome technical problems of boosting bond purchases but Draghi  emphasises ECB capabilities in this area  

Concerns around banking system also a current focus for ECB

There was no drama around today’s ECB press conference. An impressive presentation by Mario Draghi, the ECB president, indicated there were few signs of major market dislocation in the immediate aftermath of the UK ‘Brexit’ vote and, while he noted that a proper assessment of the economic impact on the Euro area wasn’t yet possible, he provided reassurance that the ECB would respond appropriately in the event that further action was required.

If the ECB is calm, it certainly isn’t complacent.  As a result, any marked evidence of weakness in upcoming surveys is likely to cause expectations of additional ECB easing in September to build.

Mr Draghi will not be unhappy that after his pronouncements today, considerable uncertainty remains as to whether the ECB will ease again, when such action might occur and what measures might be taken. However, by repeatedly emphasising that markets should appreciate that the ECB is ready, willing and able to act, he clearly focussed attention on the likelihood that some supportive measures will be announced when the ECB holds its next formal policy meeting on September 8th.

After the usual formal announcement of the Governing Council’s policy decisions, the ECB’s opening press statement today discussed at some length what was clearly the focus of attention for the past four weeks; the consequences for the Euro area of the UK vote to leave the EU.  The inclusion and prominent positioning of two paragraphs on the issue emphasised that in spite of Mr Draghi’s calm demeanour today, the recent ‘Brexit’ vote is a matter of immediate and substantial concern.

Today’s citing of the ‘encouraging resilience’ of Euro area financial markets and the ECB’s related judgement that supportive financing conditions that ‘continue to support our baseline scenario of an on-going economic recovery and an increase in inflation rates’ are clearly intended to reassure markets.

However, the subsequent acknowledgement of ‘prevailing uncertainties’, the omission of the phrase ‘but steady’ when describing the ECB’s continuing expectations that recovery will proceed ‘at a moderate pace’ and the less forceful judgement   that inflation rates should ‘increase’ rather than ‘recover’ (as suggested at the previous press conference), all represent small linguistic alterations that point towards some downgrading of an already fragile economic outlook.

The sense that an altered view of economic prospects sufficient to trigger further easing might emerge at September’s ECB policy meeting is heightened by the appearance of the word ‘very’ in the promise to ‘monitor economic and financial market developments very closely’ as well as Mr Draghi’s repeated references to the potential insight that might be provided by new ECB staff projections which would be available at that point.

Mr Draghi was pressed on a couple of occasions as to what deterioration in the economic outlook might prompt ECB action. His answers were framed in a manner designed to ensure the ECB isn’t boxed into a corner that would prescribe action on the basis of a particular scale of numerical revision to GDP or inflation projections. While he admitted the ECB had made a preliminary estimate that ‘Brexit’ would reduce Euro area GDP growth by between 0.2% and 0.5% over a two year period, he downplayed the prospective accuracy of predictions that could not hope to capture either the length of time it might take to conclude a post exit arrangement or the nature of that arrangement.

If Mr Draghi was evasive on what macroeconomic conditions might be required to prompt ECB action in September, he was even less informative but altogether clearer when asked what form possible future action might take. Repeated questioning brought the same response. Mr Draghi indicated that the Governing Council meeting had paid ’no attention to specific instruments at this time’.

Even more forcefully, when asked about possible technical difficulties because of a potential shortage of eligible government bonds, he suggested that markets should not underestimate the ECB’s capabilities to act. He noted that there was already ample evidence of the ECB’s ‘to exploit the flexibility of the design of our programmes’ to adapt them to achieve their purpose.  So, market speculation as to how exactly the ECB might amend the current boundaries of its bond purchasing programme looks set to continue for at least another seven weeks.

Today’s press conference also saw repeated questioning of Mr Draghi on the vexed issue of difficulties in Euro area banks. At the risk of understatement, the ECB’s position on various dimensions of this important topic has not always appeared consistent. Mr Draghi emphasised that current problems centred on the prospect of a sustained period of low profitability rather than solvency issues. His responses today indicated strong support of substantive action, noting that a public backstop would be a useful resource and indicating that the longer a significant problem of non-performing loans (NPLs) persists in the Euro area, the greater the adverse impact on the functioning of the banking system.

The sense that this is regarded as a key issue by the ECB at present may be suggested by the somewhat surprising phrasing of one sentence in today’s opening statement that says ‘ the Governing Council will continue to monitor economic and financial market developments very closely and to safeguard the pass-through of its accommodative monetary policy to the real economy ‘.

The reference in this sentence to monitoring economic and financial market developments is fairly straightforward and the action it implies will be taken to ensure the pass-through of the ECB’s monetary stance may be primarily focussed on liquidity measures but the ambiguity in the second part of this sentence, coupled with Mr Draghi’s comments on the impact of NPLs on the functioning of the banking system, suggests August may not be an altogether quiet month across a variety of ECB departments. At the margin, such concerns would also seem to lessen the likelihood that any further easing would include a material reduction in the ECB’S deposit rate.

While we think Mr Draghi provided several pointers towards the likelihood of a September easing, there was sufficient ambiguity in his words to avoid any clear pre-commitment.  This means market speculation as to the whether, when and what of ECB action will continue to ebb and flow in the run-up to the September meeting in response to what could be fairly volatile economic and financial indicators in the weeks ahead. In turn, this suggests the possibility of another eventful August for interest rates and currencies, particularly if upcoming survey data hint at significant Brexit effects.

 
 
 
 

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