ECB Passes on an Opportunity to Augment Stimulus

September 8, 2016

In a show of shock and awe six months ago, the Governing Council reduced its refinancing rate, marginal lending facility rate and deposit rate to zero, 0.25% and negative 0.40%, plus quantitative stimulus was expanded 33% to monthly asset purchases of EUR 80 trillion. Although not universally expected by analysts, some believed and even more hoped that stimulus would be increased at the September meeting, since such coincided with a fuller review of economic conditions and prospects including the unveiling of new macroeconomic forecasts. Projected GDP growth in both 2017 and 2018 was  in fact nudged lower, as explained in a released statement. The table below shows the evolution of the ECB growth forecasts as sequentially ensuing quarterly reviews. Officials expect growth to continue more or less steadily but at no more than a moderate pace, and risks of primarily an external nature are skewed to the downside. In the second quarter, real GDP went up only 1.1% from 1Q on an annualized basis, and year-over-year growth slowed to 1.6%. The third quarter is not expected by ECB officials to experience faster growth than seen in the second quarter.

GDP,% 2016 2017 2018
Sept 2016 1.7% 1.6% 1.6%
June 2016 1.6% 1.7% 1.7%
March 2016 1.4% 1.7% 1.8%
Dec 2015 1.5% 1.7% 1.9%
Sept 2015 1.7% 1.8%

The evolving consumer price inflation profile for 2016, 2017, and 2018 is shown below. The released statement anticipates continuing very low inflation over coming months, followed by a pick-up towards endyear based on oil price base effects, and further acceleration in 2017 and 2018. But the inflation rate in 2017 is now seen marginally lower than assumed at the time of the September economic review.

CPI, % 2016 2017 2018
Sept 2016 0.2% 1.2% 1.6%
June 2016 0.2% 1.3% 1.6%
March 2016 0.1% 1.3% 1.6%
Dec 2015 0.1% 1.0% 1.6%
Sept 2016 1.1% 1.7%

At the September meeting, monetary policymakers concluded that the Ezone economy had weathered the initial Brexit shock and that it is too early to assess how Brexit might impact growth and inflation in Euroland. In their opinion, monetary support is already “substantial,” and such is promoting economic recovery and likely to encourage an eventual rise of inflation toward the target of close, but slightly below, 2%. Such confidence existed a year ago, too, when as of August 2015 the total and core inflation rates stood at 0.1% and 0.9%. Now they are at 0.2% and 0.8%. So one can forgive market participants for their reaction of disappointment to the news that the Governing Council chose to retain the policy settings that were put in place last March.

As before, ECB policymakers promise to maintain “monthly asset purchases of EUR 80 billion until the end of March 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.” Time will tell whether such forward guidance is enough to quell market volatility. The one thing that investors and central bankers clearly agree on is that monetary policy in Euroland and other industrialized economies has been relied upon too heavily and that fiscal policy needs to be more expansionary and combined with the implementation of much more decisive structural reforms to reduce structural unemployment and boos potential output growth.

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



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