It was not at all surprising that today’s ECB Governing Council meeting left policy unchanged

 No change to outlook for activity or inflation implies no inclination to change policy.

• Continuing ‘downside risks’ mean ECB still ‘ready to act’ but only if conditions worsen sharply or deflation concerns emerge.

• Many reasons for ECB to take cautious approach at this point.

• Further easing likely to take the ECB into uncharted waters with ‘risk of unintended consequences’

• Risks of fiscal slippage in many countries also argues against further monetary easing.

• German situation becoming more delicate as healthy economy, constitutional court hearing and looming election may all influence ECB policy stance and presentation.

• Focus set to increase on other central banks, ECB may want to stay out of spotlight.


Having cut its key refinancing rate to a new all time low just a month ago, it was not at all surprising that today’s ECB Governing Council meeting left policy unchanged. Although ECB president Mario Draghi indicated that the ECB would continue to ‘monitor very closely all incoming information’ and ‘stands ready to act’ if warranted, the general tone of his remarks today suggest to us that further ECB action may not be as close as some in the market had speculated. We think it would take an unexpectedly weak Euro area economic performance through the next three to six months to prompt the ECB to ease policy further. Although the ECB will continue to offer reassurance that further support will be forthcoming if needed, a wide range of arguments suggest it will take quite a sharp further deterioration to cause it to act again.

No Major Change In Economic Assessment

Today’s ECB press conference was short on drama but it did offer glimpses of a range of factors that represent significant obstacles to further easing. Probably the most obvious argument advanced by Mr Draghi today was that circumstances haven’t changed materially in the past month in a manner that would suggest a case for further action. Mr Draghi noted the absence of any directional change in the most recent batch of indicators although he highlighted some signs of stabilisation and even a tentative improvement in some recent survey data. Mr Draghi also noted a small uptick in inflation that might also be expected to caution against a further easing.

Of far greater importance to policy prospects than the past month’s data is the fact that the ECB’s assessment of the economic outlook for the next year or two remains broadly unchanged. Today’s new set of ECB projections were virtually unchanged from those of three months ago— growth for 2013 was revised down by 0.1 percentage points (to -0.6%) while growth for 2014 was revised up by the same amount (to 1.1%). Similarly, inflation for 2013 was revised down by 0.2 % to 1.4% while the forecast for inflation in 2014 was unchanged at 1.3%. So, the assessment of the broad economic environment that informed last month’s decision to cut the refinancing rate remains largely unchanged, thereby underpinning the case for unchanged policy.

Deflation Worries Fade

We think the new projections that suggest a broadly unchanged outlook could conceal some recent easing in concerns at the ECB about the possible threat that a serious deflationary spiral might take hold. In response to a question today on deflationary risks in some Euro area economies, Mr Draghi made a surprisingly lengthy intervention on the nature of deflation which he described as a generalised and protracted fall in prices that coincided with self-fulfilling expectations and had an explosive dynamic. Mr Draghi said that across the Euro area as a whole, the recent easing in inflation was being driven primarily by a fall in energy costs that would improve ‘real’ spending power for consumers, a very different dynamic to an altogether more threatening downward spiral in prices that would prompt a postponement of spending. He did note more generalised price declines were being seen in countries where a more profound economic adjustment was taking place.

We draw a number of implications from these comments. First of all, the ECB appears to have undertaken a detailed examination as to whether a serious deflationary tendency was in prospect for the Euro area and it would seem to have concluded that this risk has diminished and is relatively low at present. Second, it may be that the ECB feels that the Euro area is instead experiencing a ‘good’ disinflation rather than a threatening deflation in that lower energy costs are supporting purchasing power generally and more specific and needed adjustments in relative prices in certain countries are also underway. In such circumstances, there would be no need to aggressively counter emerging price trends through a notably more aggressive monetary easing.

What Could The ECB Do If Needed?

The ECB still sees ‘downside risks surrounding the economic outlook for the Euro area’. This means that it is very important to reassure the markets that the ECB is able and willing to do more if needed. In this context, Mr Draghi noted that there had been ‘ample discussion today of non-standard measures including measures to enhance the ABS market, long-term refinancing operations, the additional credit claims framework and collateral policy as well as the possibility of moving to a negative deposit rate. However, Mr Draghi also cautioned against expecting too much. In the case of asset backed securities related to SME lending, he noted that this was a project of medium or long term proportions. He also continued to highlight the risk of ‘unintended consequences’ if negative deposit rates were implemented.

Significantly, any further ECB easing step is likely to push it into very much uncharted territory. Of course, it could make changes to collateral policy or it could cut the refinancing rate by another 25 basis points. Such measures might buy time but they could also highlight shortcomings in the ECB’s policy tool box that it would prefer not to bring to general attention. We feel that the balance of opinion within the ECB is that initiatives in areas such as the ABS market would not be adequate to deal with economy-wide problems. Similarly, as pointed out below, important considerations mean the scope for more radical forms of easing are severely limited. This means that a move to a negative deposit rate might be considered as a fallback to be contemplated in an extreme deflationary environment but we think the ECB feels this threat has diminished recently.

Lots Of Other Reasons Not To Act Too Soon

While we think the ECB has identified a range of further policy measures that it could employ if circumstances were notably weaker than it now envisages, we also think Mr Draghi and his colleagues are reflecting on a number of diverse factors that tend to argue against a further policy easing in the months ahead.

One concern that maybe emerging among some ECB officials is that the process of fiscal adjustment and broader structural adjustment could be threatened by a recent shift in thinking on ‘austerity v growth’. A month ago we suggested that the introduction of wording in the monthly press statement that ‘Euro area countries should not unravel their efforts to reduce their budget deficits’ might be interpreted by some as signalling the ECB’s willingness to contemplate a notably looser fiscal stance. This month’s statement, doubtlessly informed by indications of altogether more limited adjustments in a range of countries, suggests the ECB would be very unhappy to see a generalised easing of fiscal policy. The ECB now argues that ‘decisions by the European Council to extend the time frame for the corrections of exceptional fiscal deficits should remain reserved for exceptional circumstances’. In all likelihood, the pace of fiscal adjustment in the Euro area and elsewhere is likely to remain a controversial issue in coming months. While the outcome of this debate is still uncertain, it may well lessen the case for additional monetary policy to support activity.

A Delicate Time In Germany

Another important factor that has frequently caused the ECB major problems in the past is the need to balance the needs of the Euro area as a whole against prevailing economic conditions and monetary traditions in Germany. The German constitutional court is set to hold a full hearing next week on whether the ECB’s intention to implement outright monetary transactions (OMTs) is compatible with the German constitution. This means it wasn’t entirely surprising that Mr Draghi spent a good deal of today’s press conference outlining the conservative nature of the ECB actions and how they had contributed to stability in markets. He suggested that the announcement of OMTs had been ‘the most successful measure of recent time’. He noted that national ‘Target’ balances frequently cited as a major risk area by German critics of the ECB unconventional policy measures had declined of late as the impact of the announcement of the OMTs took effect. He added that the liquidity component of the Euro area money supply was now shrinking and that the ECB had been able to achieve this without inducing any volatility or creating deflationary conditions. Aside from next week’s constitutional court hearing, in the run up to federal elections, the ECB’s commentary needs to pay special attention both to current circumstances in the German economy and to the importance its people place in its particular policymaking tradition.

We also think the ECB may prefer to take something of a back seat and avoid potentially more troubling calendars facing some more ‘activist’ central banks in the months ahead. Both the US Federal Reserve and the Bank of Japan face very delicate tasks in terms of the actions they take and the manner in which they guide market expectations in this regard while the new Governor of the Bank of England also faces a formidable task in meeting the anticipation of significant new initiatives. In such circumstances, the ECB would likely prefer to emphasise the ‘stabilityoriented’ and medium term nature of its approach.

We think a range of influences now combine to make it likely that the ECB will seek to keep policy on hold for the foreseeable future even if it may continue to highlight a capacity to act again if the Euro area economy weakens or a significant deflationary concern emerges.