ECB: Threading a Narrow Path

March 4, 2010

The ECB today conveyed several things.  It

  • Announced a return to variable rate refinancing operations as of April 28th but made no change in it main weekly fixed rate tenders or its one-month tenders.  They will continue as they’ve been into October.  The final six-month tender on March 31 will carry the average minimum rate of the weekly tenders during its life: most likely 1.0%.  The phase-out of unconventional credit enhancements is proceeding more slowly than I expected initially.
  • Left its three key rates of 0.25% for the deposit rate, 1.00% for the main refinancing rate, and 1.75% for the marginal lending rate.  Very short-term Euribor rates have remained closer to the deposit rate than the refinancing rate, but as special liquidity infusions are reabsorbed, short-term market rates will glide back toward the 1.0% refi rate, which in ordinary times sets the floor for the short end of the maturity spectrum.
  • Made no substantive changes to the verbalized economic prognosis from February’s report.
  • Unveiled new staff forecasts.  The ranges for projected GDP are centered on 0.8% this year and 1.5% in 2011.  Projected CPI inflation was cut by a tenth for 2010 but bumped up by a tenth to 0.9-2.1% for 2011.  These price ranges lie below the central bank’s medium-term target.

ECB officials are trying to appear watchful and reassuring as guardian of medium-term price stability but also cautious and guarded on growth so as not to spread gloom.  They espouse tough love on needed budget cutbacks but satisfaction with the Greek austerity proposals.  The notion of Greece or any other EMU member leaving the bloc is dismissed as an “absurd” non-starter.  If outside aid is needed for a particular government to meets its debt servicing obligations, such should come from within the group, not the IMF.  In these and other ways, a lot of balancing of objectives is being done.  That’s not supportive from the euro’s standpoint, but then again, the region could benefit from a little more orderly depreciation.

ECB President Trichet’s formal statement sticks close to script, including no fresh thoughts and the deletion of no significant points.  Most importantly, the present rate structure is called “appropriate,” and medium term inflation expectations “remain firmly anchored in line with the aim of keeping inflation rates below, but close to, 2% over the medium term.”  These two point convey the message that rates do not need to be raised or lowered for a long time.  Even though inflation will be below the target until at least 2012, that has not engendered deflationary expectations.  The statement affirms that an economic recovery continues but repeats that it will be only “moderate” and “uneven.”  Three sources of growth and three drags are noted.  The stimulants are macroeconomic stimulus, other measures that were taken to restore financial market functionality, and export demand.  The depressants will be balance sheet adjustments, low capacity usage, and weak labor markets.  Considerable uncertainty surrounds this baseline forecast, but growth risks as well as inflation risks are deemed balanced.

The combination of resource slack and weak economic growth point to subdued inflation over the whole policy-relevant horizon.  The very weak expansion of the M3 money stock and loans to the private sector, which are expected to persist over coming months, are additionally consistent with low inflationary pressures over an even longer time frame.

The ECB issues new macroeconomic forecasts on a quarterly basis.  The new projections and a history of projections issued in the past are documented below.

  GDP ’09 GDP ’10 GDP ’11 CPI ’09 CPI ’10 CPI ’11
03/10   +0.4/1.2% +0.5/2.5%   +0.8/1.6% +0.9/2.1%
12/09 -4.1/-3.9% +0.1/0.5% +0.2/2.2% +0.3% +0.9/1.7% +0.8/2.0%
09/09 -4.4/-3.8% -0.5/+0.9%   +0.2/0.6% +0.8/1.6%  
06/09 -5.1/-4.1% -1.0/+0.4%   +0.1/0.5% +0.6/1.4%  
03/09 -3.2/-2.2% -0.7/+0.7%   +0.1/0.7% +0.6/1.4%  
12/08 -1.0/0.0% +0.5/1.0%   +1.1/1.7% +1.5/2.1%  
09/08 +0.6/0.8%     +2.3/2.9%    
06/08 +1.0/2.0%     +1.8/3.0%    
03/08 +1.3/2.3%     +1.5/2.7%    
12/07 +1.6/2.6%     +1.2/2.4%    

No major central bank was quicker than the ECB to enhance credit market liquidity when the global financial crisis began in the summer of 2007.  Officials have drawn a distinction between that support and monetary policy, which through the whole ordeal did not veer from the mandated goal of preserving price stability.  The ECB’s prior rate-raising cycle did not end until a 25-bp increase of the refinancing rate in early July 2008 to 4.25% by which point the 2.0% federal funds rate was already 325 basis points below its pre-crisis peak of 5.25%.  Over a seven-month period, the ECB implemented seven rate reductions: 50 bps each in October and November 2008, 75 bps in December, 50 bps each in January 2009 and March, 25 bps in April and a final 25 bps to 1.0% in May.  The cumulative decrease had been 325 basis points, the amount that the Fed had completed before the ECB even started to ease.  The Fed of course went on to slice another 175 bps from its target rate, and the U.S. fiscal deficit ballooned to a greater share of GDP than Euroland’s as a whole.  More forceful macroeconomic stimulus in the United States than Euroland, which for much of the crisis was amplified by euro appreciation against the dollar, partly explains why the U.S. recession was shallower than Euroland’s and why its recovery looks somewhat more solid now.  An irony of Greek debt crisis is that Euroland’s overall deficit to GDP ratio is lower than the U.S. one.  However, comparisons of debt to GDP favor the United States.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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