EMU: ECB Announcement

Thu Dec 14 06:45:00 CST 2017

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As widely expected, ECB policy closed out 2017 with a steady hand on interest rates and QE. The benchmark refi rate stays at 0.00 percent while the rates on the deposit and marginal lending facilities remain at minus 0.40 percent and 0.25 percent respectively.

Forward guidance was also unrevised, essentially implying no move on official rates until at least September 2018 and, quite probably, 2019.

Subject to any significant economic shocks, the policy stance for next year was effectively laid out at the ECB's last meeting in October. That foresaw a halving in the current pace of net monthly QE purchases to E30 billion from January through at least September. Interest rates will not be hiked until well after the completion of QE.

There was little of note in President Draghi's press conference although the new economic forecasts do suggest that the Council has become more optimistic. These show a significantly stronger growth profile, albeit with risks to the projection still evenly balanced. Real GDP is now put at 2.4 percent this year, up from September's 2.2 percent call and 2.3 percent in 2018, some 0.5 percentage points stronger than last time. However, the inflation outlook has been adjusted only slightly. Hence, 2017 remains at 1.5 percent while 2018 is raised a couple of ticks to 1.4 percent and 2019 also stays at 1.5 percent. By 2020, the headline HICP is seen running at a 1.7 percent yearly rate, and so still short of its near-2 percent target. The slow recovery in prices provides justification for the extension to the QE programme next year and, given the persistent undershoot, may even see some question the wisdom of reducing the size of future monthly asset purchases in the first place.

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.