The ECB Is Delighted To Be Dull


Draghi emphasises continuity in policy while highlighting improvement QE has brought about.

Key task for Draghi is to maintain confidence in bond-buying…

...although ECB may be divided on whether early end to bond buying is possible…

...and less certain than it suggests that bond scarcity may not be a problem.

Questions suggest Greece’s problems are no longer seen as systemic by observers.

Will sense of emerging ‘goldilocks’ recovery persist?

The only major surprise from today’s ECB press conference was a security breach that allowed a protestor to briefly disrupt Mr Draghi’s delivery of his opening statement.  Mr Draghi managed to remain calm and unruffled through that momentary intervention and he retained the same demeanour throughout a session in which reporters tried to explore various ways through which the ECB’S recently announced asset purchase programme might run into problems.

Mr Draghi sought to send a very clear message today but it was a message intended to have minimal market impact; a major policy initiative has been implemented, it is working smoothly with encouraging early results and it is set to continue for a considerable period of time. The strong emphasis on the continued implementation of the programme did cause bond yields to ease marginally but, by and large, Mr Draghi succeeded in persuading markets that the ECB is now on a pre-set and lengthy course.

In general terms, there was nothing particularly notable about today’s ECB press conferenceHowever, the answers Mr Draghi gave to repeated questions about the circumstances in which the programme might be re-assessed  do hint at possible complications and compromises in relation to the bond buying programme that could cause markets to become more unsettled in the future.

As the ECB’s Extended Asset Purchase Programme only became fully operational in early March, it is scarcely surprising that Mr Draghi chose to make the analogy of being in the first kilometre of a marathon but neither is it entirely surprising that the press conference focussed on diverse reasons why the programme might not make it to the scheduled finishing line in its current form. One consideration is the possibility that inflation might recover more quickly to the ECB’s target than previously anticipated.  In turn, this has raised the question as to whether ECB policy would mechanically continue on its current setting or adapt to changing economic circumstances.

The nature of unconventional policies means that the ‘signalling’ or ‘expectations’ channel is a critical element in the transmission mechanism. Should serious doubts emerge about the continuation of the programme, its impact could be substantially if not fatally undermined. The impact of a potential early curtailment could have a sharp and speedy impact on Euro area bond yields. In the current environment such a correction could cause major difficulties for a still fledgling economic upturn as well as for possibly overextended financial market positions.  So, a crucial task for Mr Draghi is to ensure markets remain convinced and calm in relation to the continuing roll-out of the bond buying programme.

He reminded the press conference on a couple of occasions that the ECB’s expectation of a progressive pick-up both in growth and inflation in the Euro area was founded on the assumption of the delivery of the bond-buying programme in full out to September 2016. In this respect, the programme might be compared to a course of medicine whose dosage is calibrated to bring about the required improvement in the health of the patient. However, it is not entirely clear how the ECB might respond to changes in the condition of the Euro area ‘patient’.

Mr Draghi seemed to give a strong signal today emphasising the persistence of the current monetary policy stance but a very careful choice of wording is designed to send a strong message while retaining significant wriggle-room if this should be required in the future. Our sense is that this approach also enables a consensus to be created between ECB governing council officials who may harbour somewhat different views as to how policy should evolve if and as circumstances change.

As in the two previous opening policy statements, Mr Draghi noted today that ‘Purchases are intended to run until the end of September 2016 and, in any case, until we see a sustained adjustment in the path of inflation that is consistent with our aim of achieving inflation rates below, but close to 2%, over the medium term.’ It is not entirely clear as to whether this wording implies bond purchases will run for at least eighteen months or might be halted earlier if inflation picks up more quickly than expected.

The use of the word ‘intended’ in this context is notable because of its rather stilted usage in previous ECB statements. Indeed, last December Draghi attempted to provide some clarification of its meaning; ‘yes, indeed, intended is different from expected. It’s not simply an expectation, it’s an intention but it’s not yet a target. So, it’s something in between. There was a vast majority of the members of the Governing Council but the decision was not unanimous.’  So, we interpret its use in the present context as a compromise that serves to create a forceful impression that bond purchases will not be curtailed before September 2016 at the earliest while allowing for some possibility that this might not be the case.

Our judgement that this reflects a compromise rather than simply a shared view of an admittedly uncertain future is heightened by Mr Draghi’s refusal to go beyond the statement wording today.  His phrasing to the European parliament on March 23rd ‘We intend to carry out our purchases at least until end-September 2016…’ was notably less ambiguous but it seems to contrast with comments made by Yves Mersch a fellow executive board member on April 8 that noted’ we are of course not so tied to our decisions that we could not adjust our course of action….We cannot in either instance turn our eyes from reality.’

To further emphasise the continuity of the current policy stance, today’s press statement sought to emphasise that policy would not be thrown off course by temporary fluctuations in inflation; ‘the Governing council will follow its monetary strategy and concentrate on trends in inflation, looking through unexpected outcomes in either direction if judged to be transient..’.   This clarification means the ECB can deflect pressure to alter its policy if, for example, oil prices were to move sharply in either direction in the months ahead.

While Mr Draghi sought to emphasise the continuity of the current policy stance, he also sought to highlight the emerging improvement in economic conditions and the related signs of a turnaround in bank lending. His comments were nuanced; While remaining on the downside, the risks surrounding the outlook for the Euro area have become more balanced…’  but his tone was notably brighter than in the past. Again, a key task for the ECB in coming months will be to strike a tone that engenders confidence in the recoveryin the economy and financial sector while not seeming to threaten the prospect of tighter policy.

In this context it is notable that the IMF in its latest projections is more downbeat than the ECB.  Although the latter sees growth accelerating from 1.5% this year to 1.9% in 2016, the IMF sees little change in growth  next year (+1.6%) and a correspondingly weaker outlook for inflation in 2016 of 1.1% against the 1.5% envisaged in ECB projections. So there is still no strong consensus that the problems that prompted more radical action by the ECB can now be regarded as fully resolved.

While a significant portion of today’s press conference was concerned with Mr Draghi seeking to downplay the possibility of an early end to ECB bond buying, there was also repeated questioning in relation to the possibility that ECB might not be able to purchase sovereign bonds in sufficient quantities to meet its specified purchase targets. Here too, Mr Draghi suggested concerns were misplaced although he didn’t elaborate precisely why ‘scarcity’ worries were altogether overdone.  His assertion ‘the programme is flexible to be adjusted if circumstances change’ and that this question is ‘to say the least premature’ hints that this may be an issue the ECB is grappling with internally without entirely satisfactory solutions to this point.

The fact that Mr Draghi was asked today both about the possibility that ECB bond buying might end sooner than announced and also questioned as to whether it might not be able to source sufficient bonds to purchase suggests that opinion is notably divided as to what form the issues the ECB may face through the coming year will take and how bond yields and the Euro might be expected to move as a result. For the moment, there seems to be an eagerness to believe that current policy settings can bring about a recovery that is robust enough to last but not so fast that it threatens a rapid rebound in inflation.

Moreover, the fact that a range of questions on Greece focussed on that country’s particular difficulties and didn’t consider the broader Euro area context emphasises how much Mr Draghi and his colleagues have achieved.  Our sense is that market sentiment both in relation to Greece and in relation to where bond yields and the exchange rate of the Euro might trade risk being too complacent. However, Mr Draghi will be more than happy if ECB policy meetings remain dull for quite a while longer.

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