ECB Announces Combination of Measures to Secure Stable Expected Inflation and Encourage Bank Lending

June 5, 2014

First, key interest rates were cut:

1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.

2. The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.

3. The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.

President Draghi’s subsequent statement added several additional steps to be taken: targeted longer-term refinancing operations up to four years in maturity, preparatory work related to outright purchases of asset-backed securities a prolongation of fixed rate, full allotment tender procedures, and the suspension of the weekly fine-tuning operation sterilizing the liquidity injected under the Securities Markets Program.  The last step ensures that the balance sheet of the ECB stops shrinking.

New quarterly growth and CPI forecasts were unveiled.  Projected GDP growth in 2014 was revised downward to 1.0% from 1.2%.  But the growth forecast for 2015 was revised upward to 1.7% from 1.5% predicted in March, and the 2016 growth forecast was left unchanged at 1.6%.  The more significant modifications concern inflation, the projection of which was cut for all three years of the forecast: to 0.7% this year from forecasts of 1.0% made in March and 1.1% last December, to 1.1% in 2015 from estimates of 1.3% made in March and December, and to 1.4% in 2016 from 1.6% predicted in March.  Officials also expect inflation in the final quarter of 2016 to be at 1.5%, down from a prior forecast of 1.7%.

ECB officials are more interested in their indications of medium term inflation than in whatever low level current inflation may be.  With pride, Draghi reiterated that medium-term inflation remains anchored and consistent with the target of below but close to 2.0%.  Today’s announcements were taken not to lift the current 0.5% inflation rate but rather “to safeguard this anchoring” of expected inflation. 

It is widely believed, and I agree, that the immediate aim of easing policy now is to see the euro depreciate. It did respond, but the 0.4% net drop against the dollar at this writing compared to Wednesday’s close in New York trading hardly even constitutes as a down-payment toward this objective.  At minimum, a 10% drop from the current level within the next six months would be required.  Whether that happens will hinge in part on follow-through actions by the ECB and whether the rhetoric of all its top officials seems consistent with a serious desire to turn the page on the stingy monetary policy that’s come before. 

For the record, the ECB is still predicting moderate recovery but with risks skewed to the downside and an eventual return of inflation toward target with risks balanced.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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