After major measures in June, no new ECB initiatives in July

Accommodative Policy signalled to stay for foreseeable future

ECB now focussed on potentially tricky task of ensuring supportive stance felt fully and widely 

Lagarde continues to call for large scale fiscal action

ECB committed to ensuring financial conditions don’t inhibit fiscal capacity

Analysis by Austin Hughes, Chief Economist

As the European Central Bank (ECB) had substantially increased both the scale and duration of its easing measures at its previous policy meeting in early June, there was little expectation of any dramatic developments at today’s ECB policy meeting. The key task now for the ECB in common with other Central Banks is to avoid over-promising or , more importantly, under-delivering. In that respect, the muted response of interest rate and FX markets testifies to today’s job being well done but ensuring easier monetary conditions continue for all could prove a tricky task.

Three policy signals to support a recovery

While not likely to be market moving, there were three important messages from the ECB president Christine Lagarde at a relatively low key press conference today. In terms of ECB policy support, the message was a lot done but a lot more to do. So, monetary policy is set to remain exceptionally accommodative for the foreseeable future. Equally important is a continuing call for fiscal policy to shoulder more of the burden in supporting an economic turnaround. Mirroring recent comments by senior Federal Reserve officials in the US, the ECB continues to argue for ’further strong and timely efforts’ policy through fiscal policy actions ‘to prepare and support the recovery’. While the immediate focus is to urge agreement on the part of EU leaders to the €750 billion European Recovery and Resilience Facility, the broader message is one of ensuring fiscal policy across the Euro area remains sufficiently accommodative.

A third message linking the other two was a strong emphasis on the ECB’s capacity to ‘effectively stave off risks to the smooth transmission of monetary policy’ to ensure the accommodative stance is fully felt. This message was forcefully signalled by Mme Lagarde’s indication that the ECB envisages using the full €1.35 trillion envelope of its Pandemic Emergency Purchase Programme (PEPP) effectively contradicting remarks by other officials that suggested it might not all be needed.

 A further important element in this third message was Mme Lagarde’s emphasis on the flexibility of the  PEPP underlined by indicating ‘we will never let capital key convergence ..impair the efficiency of the monetary policy that we have adopted’. With market sentiment still fragile, repeated reassurances emphasising the fulsome support of ECB actions are likely to be required for some significant time to come.     

ECB is encouraged but far from optimistic

ECB president, Christine Lagarde, took several opportunities at today’s press conference to list off the range of exceptional actions the ECB has taken in recent months, indicating that an evaluation of ‘comprehensive’ recent policy measures at today’s policy meeting suggested they ‘are effective, are adequate and are working.’ Mme Lagarde suggested signs of effectiveness were seen in the flow of credit to firms and households in recent months.

Possibly even more striking is the contrast in the ECB’s depiction of the current economic environment compared to that of a month ago. In June, the opening assessment of the ECB’s press statement was that  ‘Incoming information confirms that the euro area economy is experiencing an unprecedented contraction.’ The tone of today’s opening  statement is markedly different, noting that ‘Incoming information since our last monetary policy meeting in early June signals a resumption of euro area economic activity…. Both high-frequency and survey indicators bottomed out in April and showed a significant, though uneven and partial, recovery in May and June.’

Notwithstanding the ECB’S acknowledgement of recent signs of improvement, it continues to see activity well short of pre-pandemic levels and recognises that the rebound is uneven.Critically, ‘the Governing Council assesses the balance of risks to the euro area growth outlook to remain on the downside.’ Moreover, whereas the June statement spoke of  ‘the current rapidly evolving economic environment’, today’s statement speaks of a ‘current environment of elevated uncertainty and significant economic slack’, implying a more stable but weak picture has emerged.

These circumstances also translate into conditions in which inflation is expected to remain well below the ECB’s target as  it remains the case that ‘Over the medium term, weaker demand will put downward pressure on inflation, which will be only partially offset by upward pressures related to supply constraints.’

Given circumstances of modest improvement and with major difficulties, the ECB continues to signal a protracted period of very accommodative monetary policy.  While some recent pronouncements from senior Federal Reserve officials pointed towards the possibility of further easing by that Central Bank, there is little expectation of any further policy action by the ECB anytime soon. That said we should mention a slight tweak in the forward guidance in today’s statement with a linguistic strengthening in the shape of a shift to the use of the future tense (e.g   ‘We will keep the key ECB interest rates unchanged’ in today’s statement which compared to June; ‘we decided to keep the key ECB interest rates unchanged’.    

The still gloomy economic outlook means further ECB easing can’t entirely be ruled out particularly if a resurgence of the virus or disappointing economic data threaten through summer months. That said, ECB president, Christine Lagarde stated that the mood at today’s meeting suggested policy was ‘in a good place’.  So, the barriers to early action appear quite high. In this context, Mme Lagarde indicated that the ECB hadn’t discussed the possibility of a technical change to increase the multiplier determining the level of excess commercial bank reserves that are not subject to negative rates.

ECB now in implementation mode and aiming to ensure easier fiscal and financial conditions persist

While the ECB has achieved a lot in enacting major policy measures, ensuring they operate as intended means there is still a lot to do in ‘maintaining favourable financing conditions for all sectors and jurisdictions’. At present, the main market focus in this regard is on the ECB’s ability and willingness to limiting any widening in spreads between sovereign bond yields. However, the issue for the ECB is broader than that.

Mme Lagarde noted today that ‘sovereign yields are the basis of the pricing of other financial products and loans to businesses and households’ but the pressing issue is to ensure counties retain adequate fiscal capacity to undertake public policy actions in response to the pandemic. In essence, the ECB is trying to ensure that the large scale fiscal actions it sees as necessary in current circumstances are not jeopardised by ‘crowding out’ effects that in many but not all instances could fall most heavily on countries most affected by the pandemic.

While different in form to the ‘doom loop’ of the financial crisis, the ECB is clearly conscious of the risk that inadequate fiscal capacity in a country could weigh on the financial sustainability of firms and households leading to a tightening in credit standards and an associated circle of worsening  financial conditions.

The message of the latest ECB bank lending survey of an expected material tightening in credit standards in the coming quarter sits uneasily with repeated questions at today’s press conference on possible ‘cliff effects’ if or when Government guarantees/supports run out. The ECB may face further challenges to ensure the delivery of its intended monetary stance.