More Stimulus from the European Central Bank

September 4, 2014

The ECB Governing Council delivered more stimulus than anticipated today.

  • Its three interest rates were each cut by 10 basis points.  The new 0.05% refinancing rate will be flanked symmetrically by a negative 0.2% deposit rate and a marginal lending facility rate of 0.3%.  All of these are record lows.
  • Markets were reminded that previously announced targeted longer-term refinancing operations start in two weeks.
  • The central bank has agreed to start purchases of non-financial private sector assets: asset-backed securities and euro-denominated covered bonds issued by MFIs in the euro area.
  • An indirect yet implicit call for a weaker euro can be found in Governor Draghi’s statement by stating that the decisions underscore “the fact that there are significant and increasing differences in the monetary policy cycle between major advanced economies.”  Conventional wisdom holds that a currency in such circumstances that is associated with the looser monetary policy ought to depreciate, ergo fundamental market forces will depress the euro against the dollar and sterling.
  • Another coded signal can be found in the deleted assertion that risks associated with the inflation forecast are balanced.  That’s been standard in prior Council statements, but the text now says instead that officials plan to continue “monitoring the risks to the outlook for price developments over the medium term. …Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments in its mandate.”

But the Council was not unanimous in undertaking the concrete actions announced today, and that revelation opens the ECB leadership to further accusations of doing too little and being too late.  One has to suspect that inflation-phobic Germany dissented.  Even many people who don’t ordinarily follow international monetary developments know about the national German fear of hyperinflation.  So the legend goes, the Nazi democratically approved ascent to power in the 1930s would not have happened without the prior destruction of savings through stratospheric inflation.  With no offsetting catastrophe from deflation in its history, Germany’s substantial influence over ECB decision-making translates to a systematic bias that accepts lower-than-targeted inflation more readily than excessive inflation.  As recently as April, Governor Draghi said the Council sees no risk of deflation, even of the modest strain that Japan had experienced.

It’s not in the nature of public officials, including central bankers to admit mistakes, but a Mea Culpa is observable in new macroeconomic forecasts that were released today.  These can be found in the top line of the table below, and note in particular how projected inflation this year has been progressively revised downward every three months each time the forecasts get updated.  The estimate is now 0.6%, less than half as much as predicted a year ago yet double the actual rise of consumer prices between August 2013 and August 2014.  If officials thought a year ago that 0.6% inflation in 2014 was possible under the policy stance they were charting, they might have acted sooner.  But then the current situation would not have arisen, inflation would higher than now, and they’d be saying now that acting earlier was unnecessary.

GDP ’14 GDP ’15 GDP ’16 CPI ’14 CPI ’15 CPI ’16
09/14 0.9% 1.6% 1.9% 0.6% 1.1% 1.4%
06/14 1.0% 1.7% 1.8% 0.7% 1.1% 1.4%
03/14 1.2% 1.5% 1.8% 1.0% 1.3% 1.5%
12/13 1.1% 1.5% 1.1% 1.3%
09/13 1.0% 1.3%

Inflation inevitably is going to deviate from target most of the time, but the preference at the ECB is for it to get too low rather than too high before action gets taken.  The same historically can be said about the Bank of Japan, and the contrast with the Federal Reserve couldn’t be starker.  Critics of the growth of the Fed’s balance sheet should ask if they’d rather see the U.S. economy behaving like Euroland’s or Japan’s than the better way that it currently is.  In that regard, after precedents by the Fed, BOJ and Bank of England, the ECB statement at long last explicitly identifies “a sizable impact on our balance sheet” as a critical intermediary goal of today’s announced measures that are intended ultimately to “to underpin the firm anchoring of medium to long-term inflation expectations” at below, but close to, 2%.

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



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