Thoughts on Last Weeks ECB Meeting

September 12, 2017

At the European Central Bank Governing Council meeting last Thursday, officials did not modify its interest rate structure: a refinancing rate of zero percent flanked by a negative 0.40% deposit rate and a 0.25% marginal lending facility rate. Nor did the committee change the parameters of its asset purchase program that runs to December at a rate of EUR 60 billion per month. Nor was forward guidance tweaked. The committee is unprepared but close to deciding what, if any, quantitative stimulus occurs in 2018 and what such might be. Draghi thinks but wouldn’t guarantee that many details can be announced to the public by its October meeting.

The Committee’s released statement is notable for three things. Concern is expressed about the possibility of additional euro appreciation. One observes in the Q&A addendum to the statement that numerous questions tried to flesh out more information about this point. Officials are not worried about the euro’s present level, only the risk that exogenous, non-economic factors might boost the currency in a fashion that could delay returning inflation to the target of below but close to 2.0%. Draghi would not reveal what speed of appreciation or any particular euro levels might evoke a change in policy, only that the reaction function is filtered through the single mandate of reaching a medium term target in an acceptably short period of time.

Two, the statement reveals that officials are moving closer to a decision on quantitative stimulus after the current program runs out. While as we note above, Draghi retained flexibility to go public with the decision when but not before the committee is sure of how to proceed, anonymous sources have indicated subsequently that four options are on the table: 1) a 33% cut in the size of purchases to EUR 40 billion per month during January-September, 2) a deeper cut to EUR 20 billion also running through September, 3) option 1 but for only the first half of 2018, and 4) option 2 ending at mid-2018. Note that none of these considerations terminates asset purchases before 2018, and that’s consistent with the continuing failure to restore in-target inflation.

Inflation has been below target for the past four years. The longer the under-shoot persists, the greater becomes the challenge of anchoring inflation expectations to the target. The third element of the released statement providing new information involves updated macroeconomic forecast. Notably, projected inflation was revised downward for both 2018 and 2019. Downward revisions were also made at the previous quarterly review done in June as can be seen in the following table that documents the evolution of those forecasts.

CPI,% 2017-f 2018f 2019f
Sept 2017

June 2017

1.5%

1.5%

1.2%

1.3%

1.5%

1.6%

March 2017 1.7% 1.6% 1.7%
Dec 2016 1.3% 1.5%  1.7%
Sept 2016 1.2% 1.6%
June 2016 1.3% 1.6%
 March 2016  1.3%  1.6%

Projected GDP growth, in contrast, was revised higher for 2017 but left the same as predicted three months ago in the case of 2018 and 2019.

 

GDP,% 2017-f 2018f 2019f
Sept 2017

June 2017

2.2%

1.9%

1.8%

1.8%

1.7%

1.7%

March 2017 1.8% 1.7% 1.7%
Dec 2016 1.7% 1.6%  1.7%
Sept 2016 1.6% 1.6%
June 2016 1.7% 1.7%
 March 2016  1.7%  1.8%

GDP growth in 2017 was revised higher simply because growth in the first half of the year has been stronger than assumed earlier, and the more dynamic growth thus far did not reflect factors that implied front-loading, that is borrowed activity that would have occurred later in the year. The revisions made to inflation stemmed from the higher exchange rate, which will depress the cost of imports and import-competing goods.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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