ECB Governing Council Recognizes More Difficult Outlook but Keeps Policy Signals the Same

January 24, 2019

The takeaway from today’s ECB Governing Council statement is that “incoming data have continued to be weaker than expected as a result of a slowdown in external demand compounded by some country and sector-specific factors.” Officials are not in denial and explicitly consider the risks associated with their baseline outlook to be skewed to the downside regarding both growth and inflation. But the baseline scenario was not modified. Today’s meeting comes just six weeks after updated forecasts were publicized. These assumed GDP would rise 1.7% in both 2019 and 2020 and that such would be sufficient to lift CPI inflation from 1.6% this year to 1.7% in 2020 and 1.8% in 2021.

From what factors is growth supposed to be ample? Today’s statement answers, “the euro area expansion will continue to be supported by favorable financing conditions, further employment gains and rising wages, lower energy prices, and the ongoing – albeit somewhat slower – expansion in global activity.”

Elements of ECB policy remain as before.  The current levels of the refinancing rate (o%), deposit rate (-0.4%) and marginal lending facility (0.25%) were reached after cuts made in March 2016. These rates will be retained through next summer at least, and possibly longer. If forthcoming data persuade officials to lose confidence that inflation will converge upon the medium term target of below but close to 2.0%, the council is prepared to ease policy, but for now the likeliest direction of the next policy changes will be toward less, not more, accommodation. A program of bond purchases ended last month, but maturing principal on those acquired assets will continue to be invested for some time after the initial interest rate hike.  To a large extent, officials are counting on accelerating wage growth to achieve their inflation target.

In the meantime, investors can think of several possible developments that could shift the ECB’s forward guidance before interest rates are raised. The U.K. could leave the EU without a deal. U.S. and Chinese tariffs could rise sharply in March. The U.S. government shutdown could extend for another month or longer. Even without any of these possibilities, the weakening trend of European data may already have acquired a momentum of its own and deteriorate significantly further in the first half of 2019. Or world energy prices could hit a new air pocket.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



Comments are closed.