ECB Left Policy Settings Unchanged But Risks Tilted to the Downside

September 10, 2020

The deposit, refinancing and marginal lending facility interest rates of the European Central Bank have been left at -0.5%, 0.0%, and 0.25%. It’s been a year since the deposit rate was reduced 10 basis points more deeply into the red. The Governing Council led by Christine Lagarde also retained all of its quantitative policy settings including the pandemic emergency purchase program whose limit had been raised in June by EUR 600 billion to EUR 1.35 trillion.

Forward guidance remains very expansionary. Interest rates are expected “to remain at their present or lower levels until officials have seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within the projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics…. We will conduct net asset purchases under the PEPP until at least the end of June 2021 and, in any case, until the Governing Council judges that the coronavirus crisis phase is over. We will reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2022…. We intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when we start raising the key ECB interest rates…. The Governing Council continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.”

Monetary policy has become more sensitized to exchange rate developments in light of a 6.5% appreciation of EUR/USD since July 1st. Although the ECB has never targeted the euro, a sustained rise of the currency would depress future inflation, all other factors being the same. Lagarde’s introductory statement released today explicitly mentions the euro as one of the items that officials are monitoring carefully.

Regarding Euroland’s economy, officials note a rebound in activity this quarter that while strong is consistent with their earlier expectations. Services activity is lagging manufacturing, and the rebound began from an historically low base. The future remains clouded by exceptional uncertainty related to the future evolution of the pandemic, and this keeps forecasting risk tilted to the downside. Considerable spare capacity in the labor market, low energy prices, and fragile confidence are meanwhile keeping inflation far below target.

Updated macroeconomic forecasts were unveiled. Economic growth projections of 5.0% next year and 3.2% in 2022 only neutralized this year’s expected GDP plunge of 8.2%, the growth rates in 2021 and 2022 are each marginally below ones made back in June. CPI inflation, which fell to a 52-month low of -0.2% overall in August and an all-time underlying low of 0.4%, is projected to average 0.3% this year and only reach 1.3% in 2022.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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