The European Central Bank (ECB) left monetary policy unchanged, leaving interest rates on its refinancing operations, marginal lending facility, and its deposit facility unchanged at 0.00%, 0.25% and -0.40% respectively. Monthly asset purchases of €60 billion will continue at least until the end of 2017, depending on the evolution of the outlook for inflation and progress made toward the 2.0% target.
During the press conference, President Mario Draghi mentioned that the bulk of decisions on changes to the ECB’s monetary policy, particularly its asset purchase program, will likely be made at the October 26th meeting. Moreover, at today’s meeting the ECB governing council discussed different scenarios concerning changes to its current monetary policy, including the tradeoffs between the scenarios, their length and size, and related pros and cons.
New ECB Staff macroeconomic projections show an upward revision to economic growth for 2017 (up +0.3 ppts to 2.2%), but the growth outlook for 2018-19 remains unchanged at 1.8% and 1.7%, respectively. Headline HICP inflation was revised down in 2018 largely owing to exchange rate pass-through from euro appreciation (-0.1 ppts to 1.2%); similarly HICP inflation in 2019 was revised down by 0.1 ppt to 1.5%. Trend inflation measures were also revised down by 0.1 ppt in 2018 to 1.3%, and revised down about 0.2 ppts to 1.5% for 2019.
Estimates on labour productivity growth were revised up for 2016 and 2017, and broadly unchanged thereafter relative to the June projection. This may imply that trend labour productivity growth, and thus potential output growth, in the Euro Area may have been running a bit firmer than previously estimated since the Euro Area recovery began in 2014.
Market reaction was mixed. EURUSD surged above 1.20 after the press conference began at 8:30am EST while Euro Area bonds were heavily bid. However, after the press conference ended the EURUSD dipped below 1.20.
Key Implications
The Euro Area economy has been on fire, with growth averaging about 2.3% over the last three quarters – roughly double the estimate trend pace of growth. Job growth has been strong, and the breadth of the recovery across nations and industries has been impressive. This is largely why the ECB is contemplating the removal of some monetary accommodation, which is likely to start with a steady reduction in asset purchases next year.
Despite the rosy growth outlook, the lack of a sustainable uptick in inflation will ensure a very gradual removal of monetary accommodation by the ECB. The rapid appreciation of the euro in recent months provides further headwinds on the inflation front, as evidenced by downward revisions to the inflation outlook today. Nevertheless, the ECB remains convinced that given the outlook for strong economic and employment growth that it’s just a matter of time before inflation converges to its 2.0% target.
The lack of inflation is not just a European phenomenon. A notable uptick in inflation has been missing in a number of advanced economies, including Canada and the U.S., despite strong economic performances. One culprit may be mismeasurement, including the difficulty in estimating trend economic growth and unemployment rates in real-time. On that note, upward revisions to labour productivity estimates for the Euro Area may imply that trend labour productivity growth may have been higher since 2014, suggesting that perhaps there is more economic slack than was previously measured. The presence of more economic slack would be consistent with weaker inflation, explaining at least part of the current inflation puzzle.
