There is little expectation of any change in ECB interest rates

ECB more confident that negative tail risks have diminished…

• …but less confident about the health of Eurozone economy.

• So, further policy easing may be coming back under consideration.

• Opinion still likely divided at ECB, but additional weakening in activity—particularly in core economies—may forge a consensus for action.


On the surface, today’s ECB regular monthly policy announcement and press conference seemed relatively dull affairs. There was little expectation of any change in ECB interest rates or any new major policy initiative and neither were forthcoming. However, there were signs of a subtle shift in ECB thinking that keeps the door open to a further cut in official rates and also sustains some possibility of further non-standard measures.

The broad thrust of Mr Draghi’s comments today suggest the ECB has become a good deal more comfortable that the risk of extreme or ‘tail’ events have diminished considerably of late thanks in no small measure to the comfort taken by financial markets from the prospect that Outright Monetary Transactions (OMTs) would be implemented by the ECB in any threatened meltdown situation. However, looking away from the extreme, the general economic outlook for the Eurozone has become a good deal weaker. As a result, the question of whether further ECB policy action may be required could again be coming under consideration.

Subtle Downgrading Of Economic Outlook Reflects Clearly Poorer Data Of Late

Mr Draghi didn’t signal any dramatic changes in ECB thinking today and it would appear that there are still significant hurdles to be overcome before a further policy easing might be implemented. That said, the general tone of today’s commentary on the Eurozone economy was more downbeat than in recent months and more consistent with comments made by Mr Draghi on Wednesday in a speech in Germany.

Today’s opening statement belatedly but subtly acknowledged the persistence of downward momentum in the Euro area economy of late as well as the virtual inevitability of negative economic growth this year by saying activity (rather than growth) in the Euro area is likely to remain weak. For 2013, the ECB now feels ‘the growth momentum is expected to remain weak’. Again, this is more negatively nuanced than last month’s indication that growth would ‘recover only very gradually thereafter’. The ECB is also a little more explicit as to why growth will remain subdued. The opening paragraph of the ECB press statement now sees ‘the necessary process of balance sheet adjustment in large parts of the financial and non-financial sectors’ weighing on the economic outlook. Tonally, this is altogether stronger than last month’s reference to ‘ongoing tension in some Euro area financial markets’. In particular, the suggestion that ‘large parts’ are now facing difficulties may reflect increasing evidence that weakness in peripheral economies has now spread to ‘core’ Euro area countries of late.

Mr Draghi refused to be drawn on the specifics of new ECB projections for growth and inflation that will be released at the December press conference but his comments today that recent weakness is bound to influence these projections suggest the outlook for activity will be a good deal lower than envisaged in the September forecast (whose midpoint implied GDP growth of 0.5% in 2013). Mr Draghi was also very confident that inflation will fall below 2% next year and would be in line with the ECB’s mandate over ‘the policy relevant horizon’. However, while the ECB still sees inflation risks as balanced, the reduced threat of an extremely negative shock means this month’s press statement no longer repeated last month’s warning that an intensification of market tension ‘has the potential to affect the balance of risks on the downside’. Mr Draghi also strongly dismissed a question about the threat of deflation.

With extreme risks reduced but the broad outlook poorer, the focus now shifts away from the question of emergency action to whether the ECB has either need or scope to adjust its policy and what circumstances might make it contemplate doing so. Some of Mr Draghi’s comments today may be illuminating in this regard.

Rate Cut May Be Coming Back Under Consideration

Mr Draghi emphasised today that policy was already very accommodative and gave a detailed account of various initiatives undertaken in the past twelve months to support activity and the health of the financial sector. He added that the ECB’s priority was to repair the monetary transmission mechanism. He also suggested that signs of improvement in some parts of financial markets of late were the equivalent of an easing of policy. So, it is likely that the ECB reckons it has had some success in this regard. Of course to the extent that the policy transmission mechanism has been repaired, it raises the question as to whether the ECB’s standard policy is now at the right setting.

When asked why the ECB wasn’t cutting rates in light of the weakening economy, Mr Draghi responded that the ECB was ready to act with monetary policy instruments as well as non-standard measures if needed. Interestingly, when asked a now regular question as to whether a rate cut had been discussed, unlike last month he didn’t say a rate cut hadn’t been discussed at today’s meeting. Instead, he said the ECB always discusses all instruments but had decided to keep rates unchanged. Perhaps significantly, he also added that the ECB hadn’t discussed what it would do next year (could this have been a slip of the tongue and he really meant to say next month?) or how it would handle negative deposit rates. This would tend to suggest policy action may still be some distance away although this distance should be seen in terms of the economic circumstances that would justify a move rather than the precise timing of any move.

When asked later to dismiss suggestions of a rate cut next month, Mr Draghi responded that he couldn’t comment in this regard but in truth it would take compelling evidence of sharp deterioration in economic activity to build a consensus on the ECB Governing Council for a rate cut as soon as next month. That said, today’s acknowledgement that ‘while industrial production data showed some resilience in July/August, most recent survey evidence…does not signal improvements…’ would seem to suggest policymakers have moved at least slightly away from outright rejection of the possibility of a further easing towards if not quite back to the view expressed after the August ECB meeting where Draghi said, ‘We have discussed possible reductions in interest rates, but the Governing Council in its entirety decided this was not the time.’

Extreme Risks All But Reversed, Ordinary Problems Now Looming Large 

The problem now facing both the ECB and the Euro area as a whole is that while event risk may have diminished of late, the threat of a slow and painful deterioration in conditions across a range of economies may be increasing. Further emergency action is not imminent. Mr Draghi said it was entirely up to Spain as to whether to ask for a formal programme of support and he also said that the ECB was ‘by and large done’ in terms of assistance to Greece.

This leaves the Eurozone economy in a precarious position, even if financial markets appear more relaxed of late. Furthermore, at a time when the IMF has questioned the pace of fiscal adjustment across the Eurozone, today’s ECB call that Governments should be ‘forcefully implementing the necessary steps to reduce both fiscal and structural imbalances’ might suggest a quid pro quo could be needed in terms of further monetary policy accommodation to underpin a very fragile Euro area economy.