Euro Area: ECB stands pat at September meeting; will monitor FX evolution
On 10 September, the European Central Bank (ECB) reaffirmed its quantitative easing program and maintained rates unchanged at all-time lows to support liquidity conditions and preserve the smooth functioning of money markets. Moreover, following the Fed’s recently proclaimed policy shift, ECB President Christine Lagarde announced that the Governing Council will take into account the impact of future movements of the exchange rate on the inflation outlook. The ECB kept rates on the main refinancing operations, the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and -0.50%, respectively. The Central Bank also left the size of its emergency quantitative easing program unchanged at a total of EUR 1,350 billion, and reaffirmed that the purchases will be conducted in a flexible manner in order to guarantee the smooth transmission of monetary policy.
The Bank retained its current level of monetary stimulus to support the recovery. The economy contracted at an unprecedented pace in H1, hit by lockdown measures imposed to curb the spread of the virus. However, activity is rebounding robustly in Q3 thanks to the gradual reopening of regional economies and supportive fiscal and monetary policies. That said, the annual variation in consumer prices turned negative in August and is expected to remain subdued over the coming months, although President Lagarde stressed this is largely due to temporary factors. Consequently, the Bank reaffirmed that it stands ready to “adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner”.
Taking the current situation into account, the ECB sees GDP contracting 8.0% this year and rebounding 5.0% in 2021, while it foresees annual inflation at 0.3% in 2020 and 1.0% in 2021. That said, the outlook remains surrounded by elevated uncertainty stemming from possible further waves of infections and the effectiveness of containment measures, the spillover on spending decisions and supply capacity, and the sizable impact on labor markets.
Moreover, the recent ultra-dovish shift in the Fed’s monetary policy stance poses further downside risks to the outlook, as it has already translated into a stronger euro—which has surged more than 10% against the dollar in recent months. Therefore, Lagarde once again stressed that a coordinated fiscal response to the crisis remains crucial. At the same time, she reiterated that fiscal measures should be targeted and temporary, to ensure medium-term fiscal sustainability.
Commenting on the latest ECB decision, Carsten Brzeski, chief Eurozone economist at ING, noted:
“Our feeling is that the ECB today engaged in an interesting, possibly risky, verbal balancing act. Mentioning the exchange rate in its introductory statement for the first time in more than two years and stressing upward revisions of the (underlying) inflation forecasts could eventually even trigger more euro strengthening. This means the ECB seems to be concerned about the stronger euro but not too concerned just yet. At least not everyone at the Governing Council.”