EMU: ECB Announcement

Thu Sep 07 06:45:00 CDT 2017

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September's ECB meeting duly concluded with no change in key interest rates. The refi rate stays at 0.00 percent and the rates on the deposit and marginal lending facilities at minus 0.40 percent and 0.25 percent respectively. There was also no adjustment to the forward guidance which continues to anticipate interest rates remaining at their present levels for an extended period of time, and well past the horizon of the net asset purchases.

More significantly, but also in line with the majority market call, the central bank signalled no reduction in its QE programme. Net monthly asset purchases were held at E60 billion a month at least through year-end, and longer if deemed necessary. Not long ago, financial markets were looking to today's meeting to produce a recalibration of monetary policy that would include a cut in asset purchases of around E20 billion a month. Some had also anticipated a signal that QE purchases would end altogether by December 2018. That the ECB has opted to make no such change indicates that it is not yet convinced that underlying inflation is behaving as it would like. The appreciation of the euro was certainly a factor in the decision and volatility here was cited by President Draghi as adding to policy uncertainty.

However, December and the 'soft' end to the current programme are rapidly approaching and Draghi indicated that the policy recalibration will be undertaken soon. There are two ECB meetings left in 2017, on October 26th and December 14th. Since financial markets were anyway anticipating a new QE announcement next month (also hinted at by Draghi) the absence of any real news today is unlikely to dent investor enthusiasm towards the euro.

Meantime, the new economic forecasts hardly justify any shift in policy. Real GDP growth has been revised up a little this year (2.2 percent from 1.9 percent) but is unchanged in both 2018 (1.8 percent) and 2019 (1.7 percent). Risks are still seen to be broadly balanced. Problematically however, the inflation projection has been shaded lower in 2018 (1.2 percent from 1.3 percent) and 2019 (1.5 percent from 1.6 percent). Sluggish wages continue to weigh but the strong exchange rate also had a significant impact.

The bottom line is that monetary policy will continue to be eased at the same pace as seen since April through at least the end of the year. Indeed, on the basis of the new economic forecasts, there would appear to be little pressure for any reduction in QE purchases any time soon. In fact, should the euro continue to rise, it may well be that the current E60 billion/month is simply rolled forwards.

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.