ECB Makes Several Policy Changes in More Aggressive Attempt to Lift Inflation Closer to Target

March 10, 2016

European Monetary Bank officials were intent on not making the mistake of December when the previous loosening of the policy stance underwhelmed markets for its timidity.  The goals of today’s more forceful stimulus are explained in the statement from President Mario Draghi.

This comprehensive package will exploit the synergies between the different instruments and has been calibrated to further ease financing conditions, stimulate new credit provision and thereby reinforce the momentum of the euro area’s economic recovery and accelerate the return of inflation to levels below, but close to, 2%.

While very low or even negative inflation rates are unavoidable over the next few months, as a result of movements in oil prices, it is crucial to avoid second-round effects by securing the return of inflation to levels below, but close to, 2% without undue delay. The Governing Council will continue to monitor very closely the evolution of the outlook for price stability over the period ahead.

The actions announced after this year’s second policy meeting of the 25-person ECB Governing Council are

  1. Cuts of 5 basis points each in the refinancing rate and marginal lending rate to zero and 0.25%, respectively, plus a 10-bp reduction in the central bank’s deposit rate to –0.40%.
  2. A 33% increase in monthly asset purchases to EUR 80 billion.  The program will be continued at no less than this level through at least end-2017.
  3. A promise to keep the three central bank interest rates no higher than their new levels for an extended period and for well beyond the termination of quantitative stimulus.
  4. A broadening of the range of assets to be included in the central bank buying scheme to include investment-grade corporate bonds from non-financial firms.
  5. A new long-term LTRO program will be begun in June.

Growth and price forecasts were not changed substantially.  The ECB staff updates these projections on a quarterly basis.  It now anticipates growth of 1.4% in 2016, 1.7% in 2017 and 1.8% in 2018, along with CPI inflation of 0.1% this year, 1.3% in 2017 and 1.6% in the outyear of 2018.  Risks lie to the downside and “relate in particular to the heightened uncertainties regarding developments in the global economy, as well as to broader geopolitical risks.”  As for inflation, “the Governing Council will closely monitor price-setting behavior and wage developments in the euro area, paying particular attention to ensure that the current low inflation environment does not become entrenched in second-round effects on wage and price-setting.”

Monetary policy in the ECB as well as elsewhere around the world have shouldered the bulk of efforts to sustain growth and counter excessive disinflationary pressure from inflation rates that already lower than desired.  Therein lies a great danger in the ECB’s latest stimulus package, and it’s statement acknowledges this by urging for more supportive structural reforms and complementary fiscal measures.

The swift and effective implementation of structural reforms, in an environment of accommodative monetary policy, will not only lead to higher sustainable economic growth in the euro area but will also make the euro area more resilient to global shocks. As indicated by the European Commission, the implementation of country-specific recommendations continued to be fairly limited in 2015; reform efforts thus need to be stepped up in the majority of euro area countries.

Fiscal policies should support the economic recovery, while remaining in compliance with the fiscal rules of the European Union. Full and consistent implementation of the Stability and Growth Pact is crucial to maintain confidence in the fiscal framework. At the same time, all countries should strive for a more growth-friendly composition of fiscal policies.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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