Central Bank Views

ECB Refrained from Talking about Tapering, though Noted that Interest Rates Unlikely Lower


ECB President Mario Draghi poured cold water onto hawks who had anticipated a more upbeat policy statement following recent improvement in macroeconomic data. However, the central bank downgraded the inflation forecasts for three years despite upward revision on GDP growth. The forward guidance was slightly less dovish with the reference "or lower" removed. Honestly, all of us understand that, at the currently exceptionally low (some are negative) interest rates, further rate cuts would offer little help to the economy. Notwithstanding expectations that the ECB would begin preparing the market over QE tapering, the central bank maintained the easing bias, reiterating the commitment to accelerate its monthly asset purchases if necessary. The single currency remains under pressure after dropping to a one-week low against the US dollar.

On domestic developments, the ECB acknowledged that the intermeeting data have confirmed "a stronger momentum in the euro area economy, which is projected to expand at a somewhat faster pace than previously expected". Policymakers noted that "the risks to the growth outlook are now broadly balanced" and dropped the previous reference that risks were tilted to the downside. On inflation, the central bank was aware of the situation that stronger economic expansion has not yet translated into stronger inflation dynamics. The flash estimate of the HICP inflation in May decelerated to +1.4%, from +1.9% in April and 1.5% in March. ECB attributed the volatility to the movement in "energy prices and temporary increases in services prices over the Easter period". It also pointed out that "measures of underlying inflation continue to remain subdued". Therefore, "a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to build up and support headline inflation in the medium term". At the press conference, President Draghi noted that modest wage growth is a key reason to the subdued inflation rate. Despite the improvement in the employment market, Draghi indicated that many of the jobs created recently are of relatively poor quality (temporary or part-time job). He added that "we need to be patient... and persistent".

On the updated economic projections, the staff forecast that GDP would expand +1.9% this year, up +0.1 percentage point +1.8% projected in March, before easing to +1.8% and then to +1.7% in 2018 and 2019, respectively. Note that growth forecasts for 2018 and 2019 were also revised higher +0.1 percentage point from previously. On inflation, the staff revised lower the forecasts to +1.5% for 2017, +1.3% for 2018 and +1.6% for 2019. The corresponding estimates in March were +1.7%, +1.6% and +1.7%.

The closely-watched interest rate and QE outlook were not changed materially. As expected, the central bank kept the main refi rate, the marginal lending rate and the deposit rate unchanged at 0%, 0.25% and -0.4% respectively. It suggested these policy rates would "remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases". The reference "or lower" was removed in this meeting. The central bank also affirmed that the QE program would be mainained at the monthly pace of 60B euro. It would continue "until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim". The disappointment here is that policymakers have mentioned nothing about potential tapering.