The European Central Bank kept policy unchanged on Thursday and ECB chief Mario Draghi is expected to play down worries over recent softness in the euro zone economy, leaving the door open to ending lavish bond purchases by the close of the year.
Having tweaked its guidance last month to reflect solid growth, Draghi is expected to argue that the economy is humming along and that the exceptional growth readings seen around the turn of the year were never expected to be sustained.
Indeed, with the 19-country bloc’s economy expanding for 20 straight quarters and millions of new jobs created, the main debate among policymakers is about how quickly to withdraw stimulus and preserve ECB firepower for the next downturn.
In particular, policymakers will need to agree an end-date for the ECB’s €2.55 trillion ($3.10 trillion) bond purchase programme, which has cut borrowing costs and kick-started growth, even if it has failed to lift inflation back to target.
With Thursday’s decision, the ECB’s bond purchases, aimed at stimulating growth and inflation through rock-bottom debt costs, will continue at €30 billion a month at least until the end of September, or beyond if needed to prop up inflation.
The deposit rate, currently the bank’s primary interest rate tool, will remain at -0.40 per cent while the main refinancing rate will be unchanged at 0 per cent.
Attention now turns to Draghi’s news conference, during which he is expected to argue that growth is still solid and could point to higher oil prices and some improvement in underlying inflation.
But he is likely to steer clear of commentary about future policy moves, keeping the bank’s options open regarding its quantitative easing (QE) programme and what would be its first rate hike since 2011 in case the outlook continues to soften.
“Against this background, we think that President Mario Draghi will try to avoid shifting market expectations about the speed of the ECB’s exit one way or the other,” ABN Amro said in a note to clients prior to the decision.
“That means sticking closely to the text that has already been communicated and batting away journalist questions on the outlook for monetary policy.”
Economists polled by Reuters still expect bond purchases to end this year after a short taper and see the first rate hike in the second quarter of 2019, but some have started to flag risks of a delay.
While 2018 growth forecasts were unchanged at 2.3 per cent, most economists polled said the trade dispute between the United States and China would also damage the euro zone economy.
With the bond-buying scheme due to expire in September, the ECB will have to decide in June or July whether to extend purchases or wind them down. But with the risk of a global trade war still looming, it may not decide until absolutely necessary, so retaining the flexibility to adjust policy.
Business sentiment has already taken a hit, particularly in export-focused Germany, and a full-fledged trade war could quickly hurt growth - a risk already highlighted by policymakers at the ECB’s March meeting.
A key worry is that protectionist rhetoric from the United States could push down the value of the dollar, an economic anomaly as the Federal Reserve is likely to raise interest rates several times this year, a natural support for the US currency.
While US 10-year yields hit 3 per cent this month for the first time since 2014, German yields - now around 0.61 per cent - have barely edged up this year, suggesting that any ECB normalisation will be extremely slow.
A stronger euro would cap inflation, a headache for the ECB as price growth is already set to miss its near 2 per cent target, the central bank’s sole policy objective, for years more to come.
Euro zone inflation is so weak that even after the creation of 9 million jobs since early 2013, measures of underlying price growth that strip out energy and food are barely rising.
This suggests that the euro zone’s economic downturn was more severe than earlier thought and makes the recovery even more protracted.
The impact of the euro’s strength has been relatively limited so far, however. The currency is up 1.5 per cent against the dollar this year and just 0.3 per cent higher on a trade-weighted basis.
Even if the currency impact were to bite, the ECB has little scope to extend purchases much longer, suggesting it will take an extremely cautious approach to normalising policy, even if it risks erring on the side of caution and moving too late. – Reuters
