EMU: ECB Announcement

Thu Mar 08 06:45:00 CST 2018

Consensus Actual Previous
Change 0bp 0bp 0bp
Level 0.00% 0.00% 0.00%

As expected, the ECB left key interest rates and its asset purchase programme (APP) unchanged at its March meeting. The benchmark refi rate remains at 0.00 percent while the rates on the deposit and marginal lending facilities stay at minus 0.40 percent and 0.30 percent respectively. Net QE asset purchases similarly stay at E30 billion a month.

More importantly for financial markets, the central bank (unanimously) decided to remove from its official policy statement the sentence stating that 'the Governing Council stands ready to increase the asset purchase programme in terms of size and/or duration' should financial or economic conditions so dictate. In other words, the policy bias has switched from easing to neutral. Such a change has been speculated for a while now so although the announcement was probably not fully priced in, it should not come as a major surprise.

The move is subtle and actually says very little about the near-term policy outlook. Essentially, it just leaves the monetary stance as likely to be tightened as it is to be eased. However, investors will no doubt interpret the shift as the first step on the path to ending the APP and this is a necessary condition for any future increase in interest rates. As such, the euro should take the news positively at the expense of equities.

In fact, there was no obvious justification for the switch in the bias from the Bank's new quarterly economic forecasts. These show a minimal upward revision to growth in 2018 to 2.4 percent but no changes to either 2019 (1.9 percent) or 2020 (1.7 percent). Risks were seen as balanced. Meantime, the HICP inflation forecast was left unchanged at 1.4 percent this year and 1.7 percent in 2020 but nudged down a tick to 1.4 percent in 2019.

The bottom line is that the ECB is just that little bit closer to normalising policy. However, getting there is still a very long way off and with forward guidance stating no hike in interest rates until well after QE has ended (September earliest), interest rate differentials with the U.S. should continue to widen some time.

The European Central Bank (ECB) sets monetary policy for all members of the Eurozone. The highest decision-making body is the Governing Council which comprises the six members of the Executive Board and the nineteen presidents of member central banks. Policy meetings take place roughly every six weeks but, due to the sheer number of participants, a rotation system has been introduced so that the total number of votes is capped at twenty-one. The benchmark interest rate is the rate on the main refinancing operations (refi rate) which sits between the marginal lending facility rate and deposit rate. The ECB's primary objective is price stability, which is based upon a near-2 percent target for the annual inflation rate.

The European Central Bank determines interest rate policy at their Governing Council meetings. The Council is composed of the six members of the Executive Council and 17 presidents of member central banks (Bank of France, Bundesbank, etc). The Governing Council meets now meets every six weeks. The European Central Bank has an established inflation ceiling of just less than 2 percent. The ECB's measure of inflation is the harmonized index of consumer prices (HICP). Each member of the Governing Council has one vote and decisions are reached by simple majority. In the event of a tie, the President has the casting vote. No minutes are released so how individual members voted is not known.

As in the United States, European market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on European markets can be dramatic and far-reaching. The rate set by the ECB serves as a benchmark for all other interest rates in the Eurozone.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.