ECB Introduces a New Communications Strategy with Some Forward Guidance

July 4, 2013

The three ECB rates of a zero deposit rate, a 0.5% refinancing rate, and a 1.0% marginal lending rate were left unchanged as expected.  The vote was unanimous after an extensive discussion of the merits and arguments of implementing a rate reduction now. 

Officials acknowledged that monetary conditions had nonetheless tightened in certain ways since the June meeting via the rise of market rates at various points along the maturity spectrum.  They felt this change may be permanent rather than transitory and decided unanimously to respond by introducing an element of forward rate guidance.  This is a meaningful departure from the previous mantra that “the ECB doesn’t pre-commit future policy actions.” 

Forward guidance injects a downward bias in central bank interest rates, Draghi agreed in his press conference remarks.  The critical language on forward guidance in Draghi’s written statement reads

Our monetary policy stance will remain accommodative for as long as necessary. The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics. In the period ahead, we will monitor all incoming information on economic and monetary developments and assess any impact on the outlook for price stability.

In Q&A, Draghi stressed the three filters related to this guidance — first low, consistent, and predictable inflation into the medium term; second broad-based real economic weakness and finally subdued monetary and credit dynamics. 

  • On inflation, expectations are still firmly anchored by the target of “below, but close to, 2% over the medium term.  Price risks are broadly balanced.  Weaker-than-expected economic activity is the main downside potential risk.
  • The economy hasn’t emerged from recession that already is seven quarters long.  GDP in 1Q was just revised to a slightly bigger quarterly drop of 0.3%, and even improved survey evidence documents a lessening rate of contraction rather than outright expansion.  The de facto monetary tightening from higher long-term interest rates bears watching.
  • Annual lending growth to non-financial firms became more negative at minus 2.1% in May after minus 1.9% in April. 

The press conference had many questions on OMT, but this issue has become a secondary focus now that the ECB has acquiesced to some element of forward rate guidance that embodies the continuing possibility of a negative deposit rate.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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