Eurozone: ECB keeps rate unchanged ahead of bank stress test
January 31, 2014
At its 9 January meeting, the European Central Bank (ECB) kept the refinancing rate unchanged at the record low of 0.25% as the market had expected. The decision comes amid a broadly-unchanged outlook for the Euro area economy. According to the ECB, recent indicators point to a continued, albeit gradual, recovery in economic activity. Output is expected to recover at a slow pace in 2014 and 2015 and will be supported by the recovery in domestic demand and the effects of the ECB's accommodative monetary policy stance. Risks to the outlook, which remain on the downside, are related to, "higher commodity prices, weaker than expected domestic demand and export growth, and slow or insufficient implementation of structural reforms in euro area countries." Regarding price developments, the Bank sees inflation holding steady at the current level in the months ahead; however, inflation expectations for the longer run remain "firmly anchored" in line with the ECB's target of, "below, but close to, 2%."
In the statement accompanying the ECB's decision, President Mario Draghi reiterated the forward guidance adopted in the previous meeting, stating that the refinancing rate will remain, "at present or lower levels for an extended period of time." He also emphasized that monetary authorities, "remain determined to maintain the high degree of monetary accommodation and to take further decisive action if required." According to analysts, the phrasing of the statement suggests that the ECB is ready to step up, in particular in the case of a further slowdown in inflation, which could undermine the incipient economic recovery. Taking this setting into account, FocusEconomics panelists expect the policy rate to end 2014 at 0.48% and 2015 at 0.60%.
On 31 January, the European Banking Authority (EBA) disclosed its criteria for conducting a stress test on 124 of banks in the European Union. The stress test is designed to show whether banks will be able to keep adequate level of capital in the case of an economic downturn. To pass the test, banks will have to show that capital will not drop below 5.5% of their assets if there is an economic crisis. This requirement is higher than the 5.0% that was set in the last stress test that was conducted in 2011. The exercise, which aims to quell doubts regarding the solidity of the EU banking system, is one of the steps that must be taken in preparation for the ECB to take on its role as single supervisor of the Euro area's banks in November. Results of the EBA's stress test will be combined with the outcome of the Asset Quality Review (AQR) - conducted by the ECB and currently under way - to determine the size of the each bank's capital shortfall.
Author: Armando Ciccarelli, Head of Data Solutions