Eurozone: ECB on hold, signals action as early as June
May 8, 2014
At its 8 May meeting, the European Central Bank (ECB) kept the refinancing rate unchanged at the record low of 0.25% as the market had expected. However, ECB President Mario Draghi clearly hinted at further monetary easing—and possibly unconventional monetary policy action— as early as next month to fight the persistently low inflation that is crippling the incipient Euro area recovery.
The ECB kept rates on hold amid a broadly unchanged outlook for the Euro area economy. The economic recovery continues to power ahead, although at a moderate pace. Risks to the outlook remain on the downside; according to the ECB, “[g]eopolitical risks, as well as developments in global financial markets and emerging market economies, may have the potential to affect economic conditions negatively.”
Regarding the outlook for price developments, the ECB acknowledged that inflation will remain low over the course of 2014, “before gradually increasing during 2015 to reach levels closer to 2% towards the end of 2016.” That said, inflation expectations remain firmly anchored and risks to the inflation outlook are broadly in balance.
In the statement accompanying the ECB’s decision, President Mario Draghi reiterated the forward guidance adopted in the previous meeting, stating that the ECB continues, “to expect the key ECB interest rates to remain at present or lower levels for an extended period of time.” Moreover, Draghi stressed that the ECB, “will maintain a high degree of monetary accommodation and act swiftly, if required, with further monetary policy easing.”
The commitment to action against a scenario of persistently slow inflation was further stressed in the subsequent press conference. President Draghi announced that, “the Governing Council is comfortable with acting next time,” a clear signal that the ECB may intervene as early as next month. That said, action is pending the release of the new inflation projections—also due at the next meeting—as a further cut to the inflation forecast could provide the base for intervention. It is, however, not clear yet which policy the ECB will adopt. Analysts are speculating that, along with a refinancing rate cutm, the ECB may decide to adopt a negative deposit rate. According to Pernille Bomholdt Nielsen, analyst at Danske Bank Markets:
“…negative rates imply a higher cost from holding deposits at the ECB, causing an intensified search for positive yields among investors. The search for alternatives could among other things help reduce fragmentation, as strong banks would be given more incentive to lend to weaker banks.”
Moreover, a negative deposit rate may have a dampening effect on the strong exchange rate, which, according to Draghi,“in the context of low inflation is cause for serious concern in the view of the Governing Council.”
Author: Armando Ciccarelli, Head of Data Solutions