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No major change in ECB assessment of economic or inflation outlook
But assumptions underpinning new projections underline future pressure to ease
Cautious press conference performance by Draghi hints at different opinions within ECB
Will markets continue to give ECB the benefit of the doubt?
There were no major surprises from today’s ECB Governing council meeting. All key official interest rates and other policy parameters were left unchanged. More importantly, Mr Draghi was very guarded in relation to future ECB actions. There were no strong signals as to whether or when policy might be eased further. Nor was any clarity provided as to how what are now becoming reasonably pressing technical constraints on the ECB’S capacity to continue its current Government bond purchase programme might be overcome.
Mr Draghi was particularly careful in his comments today. This likely reflects a significant measure of uncertainty about the economic outlook. Our guess is that it also owes something to a lack of consensus within the ECB’s Governing council on what could and should be done next. This might become a focal point for markets in coming months.
Given its importance to the ECB's monetary policy stance, it was quite remarkable to hear Mr Draghi suggest that there had been no discussion at the Governing council as to whether the ECB’s asset purchase scheme might be extended or what might be done to address a prospective scarcity of some Governments’ bonds affecting the programmes purchases in coming months. Instead, he merely suggested that ‘relevant committees’ within the ECB would be tasked with evaluating options to ensure ‘a smooth implementation’ of the programme.
There was a fairly muted market reaction to today’s ECB pronouncements which suggests that at least for now investors are willing to give Mr Draghi the benefit of the doubt in what remains a quite unclear situation. This is at least partly due to Mr Draghi’s ability to weave together a series of ambiguous remarks that hinted that further decisive action would be forthcoming if required while emphasising that monetary measures already undertaken had put the Euro area economy on a sustainable path of modest growth and gradually increasing inflation. As we discuss below, markets may also take the view that the ECB may have little option other than to ease further.
At the previous ECB press conference in July, Mr Draghi had at least hinted at the possibility of a further easing in ECB policy today if Brexit –related downside risks to the Euro area crystallised in the shape of a notable downgrading of the growth outlook or a marked deterioration in financial conditions. But while acknowledging the persistence of downside risks today, the ECB president repeatedly emphasised ‘…the available evidence so far suggests resilience of the Euro area economy to the continuing global economic and political uncertainty...’.
In July, Mr Draghi had highlighted the importance of the role of new ECB projections in shaping Governing Council thinking on the need for a policy adjustment today. While the table below indicates that there has been a marginal decline in activity forecasts for 2017 and 2018 and an equally small downward adjustment to the inflation forecast for next year, Mr Draghi summarised the Governing councils assessment of these revisions by noting ‘For the time being, these changes are not substantial as to warrant a decision to act.’
At the margin, we could envisage a somewhat weaker trajectory for activity and inflation than the new ECB projections entail. However, in other circumstances (perhaps where ‘ammunition’ was not in short supply), it is not hard to imagine that even this modest downgrade to the outlook for already fragile trends in GDP and consumer prices, when combined with a continuing balance of risks to the downside, might have been used to justify a policy easing today.
Importantly, as table 2 below indicates, there is a strong sense that further ECB action is already fully priced in by markets. The new ECB projections encompass an assumption of notably more favourable financial conditions than were envisaged in June. In particular, the assumed level of 10 year bond yields is markedly lower than in either of the two previous projections and this decline is comparable with the impact that might follow from an aggressive monetary policy easing. In part, this may stem from financial markets assessment of a more subdued global outlook and but it likely also reflects strong market expectations that the ECB will be able and willing to extend its asset purchase beyond the potential end date of March 2017.
A couple of comments made by Mr Draghi today hint, in a roundabout way, at how market thinking expressed in terms of current yield levels may have backed the ECB policy into a corner in terms of policy direction in the months ahead. He noted that the ‘existing projections remain conditional on exceptionally favourable financial conditions that to a large effect reflect the monetary policy stance’. He also indicated that this reflected an assessment of the future as well as the current stance of ECB policy by observing that ‘low rates do reflect to some extent expectations of a continuation of the extraordinary monetary support that has been extended.’
Some ECB Governing Council members would be very unhappy to be backed into a corner. In light of significant uncertainties about the economic and financial outlook, it would not be surprising if there were some differences of opinion around the ECB Governing council table on the case for further ECB easing. Our guess is that differences run much deeper both in relation to the merits of further monetary action in current circumstances and in terms of particular concerns with specific actions such as moving deposit rates further into negative territory or abandoning the capital key as the basis for Government bond purchases.
The ECB now has a relatively short time to arrive at a workable consensus on these vexed issues. Mr Draghi’s guarded approach today suggests there is much ground to be covered. The immediate market reaction today suggests that Mr Draghi might have until the December policy meeting to outline the ECB’s next step. However, we think the window could close somewhat sooner, implying a need for at least clearer policy guidance at the late October meeting.
Significant tests could come in the shape of another soft spot in a very uneven economic upswing- a now regular occurrence in the Euro area and elsewhere. Another risk would arise if there were significant technical difficulties in sustaining the current pace of Government bond purchases in the months ahead. A notably more troubling development could be a Euro area variant on ‘taper tantrums’ if concerns arose that the ECB might contemplate stopping or reducing its Government bond purchase scheme at the mooted end date of March 2017. For the moment such an outcome is not really a worry for the market but a lot could change in the next month or two.
This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.