EMU: ECB Announcement

January 19, 2017 06:45 CST

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As widely anticipated, the ECB announced no changes to key interest rates at its January policy meeting. The benchmark refi rate remains at 0.00 percent and the rates on the deposit and marginal lending facilities stay at minus 0.40 percent and 0.25 percent respectively. Asset purchases were also held at E80 billion a month until the end of March when they will be reduced to E60 billion/month through at least year-end, as previously outlined in December. However, the central bank similarly reiterated its flexibility with regards to both the size and duration of its purchases according to future economic developments.

For once, the ECB must have been quite pleased with the way the Eurozone economy has performed since its last session. Fourth quarter growth looks likely to weigh in at 0.4 percent - 0.5 percent (preliminary flash estimate due 31st January) and inflation, while still uncomfortably low, seems to be finally picking up on both headline and underlying measures. In any event, having already essentially laid out the policy template for 2017 in December, today's meeting was always going to be a relatively low key affair anyway.

Nonetheless, ECB Chief Mario Draghi's press conference was again cautious and emphasised the perceived need for continued substantial monetary accommodation for price stability objectives to be met medium-term. Growth risks remain tilted to the downside, albeit largely due to global factors, and there are still no convincing signs of a sustainable rise in underlying inflation. Draghi also pressed again for a faster pace of structural reform as well as support from fiscal policy to bolster the economic recovery where possible within the confines of the growth and stability pact.

There is nothing new of any note in today's announcement and certainly no reason for expecting any deviation from the current policy stance any time soon. Absent some significant surprises in the economic data, the next several ECB meetings could be amongst the least interesting for financial markets for some time. And such a scenario would certainly not upset the central bank.

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.