This month’s ECB press conference was a relatively dull affair

ECB sees sluggish recovery and persistently low inflation.

• Risks still to downside. So, further easing can’t be entirely ruled out.

• Mr Draghi says full impact of recent action yet to be seen and highlights practical difficulties to further easing.

• We think ECB now on hold but see three circumstances where more action could come.

• A sharp deterioration in economic environment
• Extremely negative inflation in some countries
• A suitable ‘funding for lending’ scheme is found

After last month’s fireworks, it was hardly surprising that this month’s ECB press conference was a relatively dull affair.The ECB expects a gradual improvement in activity to take hold but progress is expected to be fairly slow. As a result, inflation should remain very low for some time to come.

An outturn along these lines would mean that the ECB shouldn’t need to alter policy again for some considerable time. Mr Draghi did emphasize that the ECB was both willing and able to ease policy further if needed. However, the general tone of his comments today suggests the ECB doesn’t expect to act again anytime soon.

The immediate market reaction that saw the Euro rise against the US Dollar and the German bund underperform might suggest markets expected Mr Draghi to provide clearer pointers towards a further easing today. We think further ECB easing will require notably poorer circumstances than the sluggish recovery and low inflation envisaged in today’s new ECB projections.

We think there are several reasons why the ECB might be reluctant to act any time soon. First of all, the ECB thinks it will take time for the actions it has already made to take effect. Mr Draghi noted the positive reaction of markets to last month’s surprise action but emphasised that the full effect could not be ‘instantaneous’. Second, Mr Draghi noted today that much needed structural reforms will inevitably weigh on activity in the near term. So, monetary policy can’t be expected to counter all the headwinds to growth.

Finally and possibly of most significance, it has to be recognised that any further easing would probably be what could only be described as nuclear in nature as it is likely to entail either a move to negative deposit rates or a new asset purchase scheme. For these reasons, we think the ECB will be slow to ease policy further. However, Mr Draghi did hint today at some circumstances in which further action might be contemplated.

The new ECB projections presented today envisage a fairly lacklustre recovery through the next couple of years. While the GDP forecast of 1.1% for 2014 is in line with the consensus, it implies fairly sluggish conditions through the coming year and the ECB doesn’t anticipate any dramatic improvement in 2015, where it expects a somewhat weaker GDP growth performance than the Commission (+1.5% v +1.7%). The tentative nature of the recovery and the ECB’s continuing acknowledgement of downside risks to this outlook hold out at least some possibility of a renewed weakening of activity of a sufficient magnitude that would necessitate a further ECB easing.

As has been the case for some time, Mr Draghi sought to reassure markets that the ECB is technically ready and prepared to ease further if required. Mr Draghi wants to reassure markets in this regard. In the process, he will also want to emphasise that the ECB is in a very different place in terms of near-term policy to that of the US Federal Reserve. However, he was also relatively vague today as to what policy instruments would be deployed or the precise circumstances in which policy might be altered. When asked if action might be taken against very low inflation or only against deflation, he replied that the ECB hadn’t firmly decided ‘which instrument against which contingency’, adding, perhaps surprisingly, that ‘the Governing council...hadn’t done any reflection on that’. We read this as suggesting the ECB isn’t close to further action at this time. While it wants to keep markets alive to the possibility of further easing, it doesn’t want to encourage the view that it is either probable or looming. 

We think that there are two other possible sets of circumstances in which the case for further easing would become notably stronger. Today’s new projections for inflation see an outturn of just 1.1% in 2014 and 1.3% in 2015. Again, any notable undershoot of these forecasts would likely require further easing. We also think that in contrast to the historic past, differences in inflation across countries could have some influence on ECB thinking. Mr Draghi again referred today to the difficulty some countries could face in sustaining adjustments entailing continuing falls in nominal prices and wages. Where a low inflation rate at the aggregate level of the Euro area makes further large nominal declines in prices and wages inevitable in some countries, the ECB may be at least a little more willing to contemplate more accommodative policy action.

We think a further practical consideration needs to be borne in mind when considering the prospect of fuller ECB action. This is the difficulty in finding new and suitable policy instruments in the current environment. Mr Draghi spoke at some length about the need to find a liquidity instrument that would ensure extra access to credit reached businesses and households. He said that another longterm refinancing operation (LTRO) might have little merit if it merely subsidised banks by allowing them run a ‘carry trade‘ using ECB funding to purchase Government bonds.

Our sense is that if the ECB could devise a scheme that would clearly translate into greater access to credit on the part of businesses and households, they would introduce it. However, Mr Draghi›s reference to the practical complications in devising mechanisms to ensure that such schemes reach the targets for which they were designed hints that the ECB is still some distance from finding a suitable ‘funding for lending’ mechanism, even if this is an area where they see good grounds for further action.

If further ECB action were easy to deliver, we think Mr Draghi would likely have taken out some insurance against the possibility that even today’s projections for sluggish growth and uncomfortably low inflation prove too optimistic. However, last month’s action was probably as much as could be done without venturing into very uncharted territory.

In the near-term, the ECB is likely to concentrate on further verbal easing to counter any rise in the exchange rate of the Euro or any unwanted firming in market interest rates. The big unknown is whether a still fragile Euro area can avoid the sort of weakness in activity or inflation that might force the ECB to devise and implement altogether more radical action.