EMU: ECB Announcement

Thu Apr 26 06:45:00 CDT 2018

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This month's ECB meeting concluded with the universally expected decision to leave policy on hold. The benchmark refi rate (0.00 percent), deposit rate (minus 0.40 percent) and marginal lending rate (0.25 percent) all remain at the respective levels to which they were last cut back in March 2016. The asset purchase programme (APP) was similarly untouched leaving monthly net QE purchases at E30 billion through at least September.

There was also nothing new on forward guidance which continues to see the central bank expecting key interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.

There was never likely to be any surprises here so the real focus today was on what ECB Chief Draghi had to say, particularly with regard to the recent slowdown in the Eurozone economy. To this end, he acknowledged that there had been some moderation in most countries and most sectors - possibly in part due to temporary factors such as the bad weather, strikes and Easter effects. However, he also maintained that the upswing remained both solid and broad-based and suggested that some normalisation after a robust 2017 was only to be expected. Indeed, the main threat seemed to be related to the rising risk of protectionism. Predictably, there were no changes to the Bank's view of inflation: policy is expected to achieve its price stability goals in due course but the Governing Council is frustrated by the ongoing sluggishness of the underlying rate.

In sum, recent economic developments appear to have had little impact on the ECB's thinking. The monetary authority continues to believe that the current accommodative stance is necessary to meet the HICP target but, at least so far, it is not particularly concerned by slower economic growth. Nonetheless, should the first quarter deceleration be extended into the current quarter, the current soft September end date for asset purchases will become still softer and the first hike in interest rates pushed even further into the distant future.

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.