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No major change in ECB thinking but increased attention on weaker outlook
Marginal downgrades to projections sees inflation not reaching target until 2021
ECB still confident about upswing but acknowledges increased uncertainty
Draghi highlights ‘optionality’ in future policy
ECB ends net Asset Purchases as planned but markets see this as a recalibration rather than a tightening
Limited market reaction suggests entrenched ‘lower for longer’ view on interest rates
The main message from today’s European Central Bank policy meeting is that the ECB remains on a long and slow path to policy normalisation and, while no change to that path is envisaged at this point, it continues to emphasise it has both the flexibility and the capacity to adjust policy if required.
New ECB projections show minor downward adjustments to growth and suggest it may take until 2021 rather than 2020 to reach the ECB’s inflation goal. While the ECB continues to see risks to the outlook as broadly balanced, it notes that ‘the balance of risks is moving to the downside’. Accordingly, today’s pronouncements underpin the view now prevailing in markets that ECB policy rates look set to remain ‘lower for longer’.
Although ECB president, Mario Draghi repeatedly acknowledged a softer trend in recent Euro area activity indicators, this was not deemed significant enough to prevent the ECB from confirming the planned end to net purchases under its Asset Purchase Programme this month.
The key task for Mr Draghi at the regular press conference that followed today’s ECB policy meeting was to strike a balance that avoided either ignoring or over-reacting to recent signs of a clearly weaker trajectory in Euro area economic growth. The ECB did this by tweaking growth and inflation forecasts lower and through Mr Draghi’s lengthy discussion of current ECB thinking and the flexibility it offered in terms of future policy.
The ECB president summarised the Governing council’s assessment, describing it as one of ‘continuing confidence with increasing caution’. Importantly if understandably, he remained quite evasive on future policy changes such as any shift in the timing of interest rate changes or the possible introduction of a new Targeted Long Term Refinancing Operation (TLTRO) or even the technical details related to the reinvestment of its Asset Purchase Programme (a press release issued after the press conference was not notably more informative).
Mr Draghi noted that in current circumstances of ‘great uncertainty’, the formulation of the ECB’s guidance ‘wants to keep optionality as a dominant feature’. This could be interpreted as suggesting that in the event of a further deterioration in growth and inflation prospects, tweaks to policy could readily emerge.
Such tweaks might include a new TLTRO- which Mr Draghi said the ECB were‘reflecting’ upon but had not discussed substantively. There could also be scope to alter the maturity timeframe of APP reinvestments or other related measures that could would not violate ‘the principle of market neutrality’ but might be presented as a form of policy easing or at least as copper-fastening a commitment to a ‘lower for longer’ policy stance.
By indicating that reinvestments would be distributed over a year to ensure a regular market presence on the part of the ECB and signalling a ‘gradual’ adjustment towards the amended ECB capital key, the ECB has retained a significant measure of flexibility in managing reinvestments that allow for at least the possibility of policy focussed purchases.
Given the poorer trajectory of the Euro area economy of late, it is not entirely surprising that the ECB might be examining its policy options in some detail. However, Mr Draghi was firm both in his argument that any slowdown will be contained and also in his assertion that the markets understanding of the ECB’s reaction function meant financial conditions had already eased to at least partly offset the slowdown.
Mr Draghi suggested that, in the view of the ECB, a climate of uncertainty is one of the reasons if not the main reason for softer growth of late and this development was responsible for the increase in risk premia of late. To the extent that uncertainty rather than more fundamental factors is driving current weakness, it is likely to prove more limited and transitory and, consequently, presents less of an argument for any policy response.
Mr Draghi’s opening statement also emphasised the continuing solidity of Euro area domestic demand although new ECB projections show marginally weaker consumer spending growth for 2018 and a slightly larger and lasting downgrade to investment through to 2021. In the same vein, Mr Draghi also highlighted improving wage growth but the new projections envisage marginally weaker wage growth in 2019 and 2020 than those of three months ago although an acceleration is seen in the ECB’s initial estimate for 2021.
While higher oil prices necessitate an upward adjustment to the forecast for 2018, the ECB’s new inflation projections for coming years are also marginally lower than those of three months ago. Significantly, ‘core’ inflation is cut from 1.8% to 1.6% for 2020 and only reaches the 1.8% pace consistent with the ECB’s targeted ‘below, but close to, 2%' in 2021. While it can be argued that such changes are both marginal and largely technical, they serve to paint a picture of a longer journey to reach the ECB’s desired outcomes and a correspondingly slower path to policy normalisation.
There was little market reaction to today’s ECB pronouncements or projections or to the long signalled decision to end APP net purchases. At the margin, there was some initial spread tightening that could reflect the flexibility inherent in the new parameters for reinvestment purchases. In this respect it could be argued that the ECB is seen to be implementing a non-tightening recalibration of policy.
This suggests that investors interpret the ECB’s stated commitment to keep policy rates ‘at present levels at least through the summer of 2019, and in any case for a s long as necessary..’ as very much an open ended promise that in the absence of dramatic changes in economic conditions will keep the ECB on the sidelines for some significant time.
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