ECB Focussed On Policy Implementation But Continues To Strike A Dovish Tone


Draghi highlights likely major impact of measures now being rolled out

Downside risks have eased but not ended

So, ECB won’t entirely rule out further policy support

New projections see marginally higher inflation and growth this year but details notably more downbeat

Little discussion of Brexit but risks acknowledged

Greece must do more for access to ECB refinancing operations

There were no fireworks at today’s ECB press conference, as markets appear willing to concentrate their attention on the implementation of recent ECB easing rather than clamour for the announcement of further policy actions.

At the margin, the generally dovish tone of Mr Draghi’s comments and the impact of various easing measures that only start to take effect this month seem likely to restrain the upside for Euro area market interest rates and the exchange rate of the Euro.

The press conference also summarily raised and dismissed the prospect of ‘Brexit’ and suggested the Greek government still faces some important hurdles before its bonds can be allowed as collateral for ECB loans.

The relatively calm backdrop to today’s ECB policy meeting owes much to the fact that some of the more interesting elements of the package of easing measures such as the new Targeted Long Term Refinancing Operations (TLTRO II) and the Corporate Sector Purchase Programme (CSPP) that the ECB announced as part of its March actions, only begin to be rolled out during June.

A further important consideration is that traders sense some improvement, albeit still tentative and uneven, in recent Euro area economic data. These reasons, as well as more pressing concerns both in relation to the policy intentions of the US Federal Reserve and the looming EU referendum in the UK, mean financial markets and the ECB are very much in watching and waiting mode at present.

Previous Initiatives Yet To Take Full Effect But More Could Be Done If Necessary

Two related key messages from Mr Draghi’s press conference today are that the ECB now sees itself very much in implementation mode and that the nature of its current actions means that their full force will take some time to be felt.

However, there was also an important subtext in Mr Draghi’s remarks today that emphasised a willingness to ease policy further should that be required. He forcefully responded to one question that there was ‘ample evidence’ from the measures it had recently taken that the Governing Council was ‘able, willing and ready’ to act. While the ECB president indicated that downside risks had reduced somewhat of late, he opted to emphasise their persistence.

Mr Draghi also set out the circumstances in which the ECB would contemplate further action. He said it would act if either an unwarranted tightening in financial conditions or second-round effects from recent weakness in commodity prices altered the outlook for inflation. So, either significant financial market disruptions or a notably weaker trajectory for inflation could prompt a renewed focus on further easing.

Mr Draghi Emphasises What’s in the Pipeline

There were no major surprises either in Mr Draghi’s opening press statement today or in the manner in which he responded to questions at a fairly dull press conference. An important aspect of the statement and his remarks to the press was the emphasis placed on the stimulus yet to come from the package of measures announced by the ECB in March. This reflects far more than the usual lags in the operation of monetary policy as, thus far, many of the initiatives launched in March have yet to move much beyond an announcement effect.

Between now and March 2017 (the earliest end date envisaged for these measures) ECB asset purchases will amount to an estimated €800bn, giving a major boost to the ECB’s balance sheet which currently stands at just under €3,100bn.

An expected substantial uptake of this month’s tranche and subsequent windows of the four year funding TLTRO II, which provides access to four year funding at rates between 0.0% and -0.4% depending  on the lending performance of the respective bank, implies a potentially larger boost to liquidity conditions.

The prospective scale of the CSPP entailing purchases between €5 and €10bn per month means its ‘macro’ impact may be more modest than other measures. However, it will have a significant (and possibly contentious) impact on an important market segment.

Slight Upgrade to Near Term Outlook but Details More Dovish

The general tone of today’s ECB pronouncements was dovish. Following an adverse market reaction in March to remarks made by Mr Draghi that were interpreted as suggesting that ECB policy easing might be at an end, there appears to be a determined effort not to frighten traders into thinking about a turning point in the Euro area rate cycle.

In part, this reflects a desire not to provoke any tightening of financial conditions. As we discuss below, it may also reflect a relatively downbeat view of the outlook for Euro area growth and inflation which is suggested by today’s new Euro-system economic projections.

Today’s ECB projections were notably less optimistic than might have been expected, particularly as they should now incorporate the full estimated impact of the ECB’s March easing package. The previous projections in March only incorporated the effects in so far as they were priced into markets at the forecast cut-off date of mid-February.

After a strong Euro area growth figure for the first quarter, an upward revision to this year’s GDP estimate was all but inevitable and duly arrived (to +1.6% from 1.4% in March) but an unchanged GDP figure for 2017 (+1.7%) and a marginal downgrade to the 2018 number (to +1.7% from +1.8%) suggests the ECB doesn’t see the strong start to this year translating into any lasting additional impetus to growth.

The breakdown of the new GDP estimates is not particularly encouraging either. While employment is revised up this year (to +1.1% from 0.9% in March), consumption growth is unchanged this year because of weaker wage growth (+1.3% from 1.5%) and consumer spending is marginally weaker than previously envisaged both in 2017 (1.7% against 1.8%) and in 2018 (1.5% against 1.6%).

Admittedly, these are fractional downgrades but the direction of change matters. In a maturing recovery one might expect to see some sustained acceleration in consumption growth as it is through such a dynamic that a generalised pick-up in consumer prices is most likely to occur. Instead, the ECB is paring back its forecasts in this area.

The new ECB projections also envisage a once-off and fractional upgrade to inflation in 2016 (to 0.2% from 0.1% previously) as a result of the assumed persistence of higher oil prices. Forecasts for headline inflation for 2017 and 2018 have been left unrevised (at 1.3% and 1.6% respectively). More importantly, however, the ECB has revised down its forecast for ‘core’ inflation-excluding energy, food and indirect taxes- for 2016 (to 0.9% from 1.1% in March), for 2017 (to 1.2% from 1.3%) and 2018 (to 1.5% from 1.6%).

So, implicit in the new projections seems to be the view that the Euro area’s propensity to generate a notable acceleration in inflation is very limited, even in the face of the ECB’s venture into unprecedented monetary accommodation. In a sense, this is simply reflecting the view of the ‘new normal’ already priced in to market interest rates (and elsewhere).

If higher inflation fails to materialise-beyond the expected uplift from energy related base effects later this year, pressure for further ECB easing may well return even as markets increasingly question its effectiveness.  In that event, a focus may also turn towards the prospect of fiscal stimulus. In this context, today’s new ECB projections see a somewhat smaller structural Government budget deficit in the Euro area in all three years between 2016 and 2018 than envisaged three months ago.

Waiting on the UK and Greece

There were a couple of side-bars to today’s ECB press conference. In discussing downside risks to the Euro area growth outlook, the opening press statement singled out ‘the upcoming British referendum’ while Mr Draghi noted that ‘the UK and Europe and the Euro zone are mutually beneficial’. He also suggested the ECB is ready for Brexit (should it occur) but, perhaps surprisingly, there was little probing of Mr Draghi by the media as to the likely scale or scope of consequences for the Euro area if the UK were to decide to exit the EU.

Finally, today’s press conference confirmed the ECB did not re-introduce a waiver that would allow Greek government bonds be used as collateral in ECB refinancing operations without an investment-grade credit rating. While Mr Draghi confirmed the Governing council had discussed the matter and acknowledged progress made by Greece, no decision had been made. Mr Draghi suggested the Greek government’s implementation of agreed programme measures could prompt a future ECB policy meeting to ratify the restoration of the waiver.


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