ECB Maintains Interest Rate Levels and Forward Guidance and Announces Near-Term increase in Pace of PEPP Bond Buying

March 11, 2021

This week’s monetary policy review by the Governing Council of the European Central Bank left the interest rate structure unchanged, with a zero percent refinancing rate flanked by a negative 0.5% overnight deposit rate and a +0.25% rate on the marginal lending facility. Euroland has been less successful than many other places rolling out Covid-19 vaccines; the need for fresh pandemic restrictions led to negative GDP growth in the final quarter of 2020 and apparently in the present quarter as well. In response, the ECB plans to increase the pace of bond purchases next quarter to a significant degree. Other quantitative policy tools are being continued, and forward guidance points to a forcefully accommodative ECB stance continuing for the foreseeable future.

The ECB Governing Council unveiled updated macroeconomic forecasts at today’s press conference. Scant change was made in projected GDP growth: the estimate for 2021 was nudged 0.1 percentage point higher to 4.0%, that for 2022 was nudged down 0.1 percentage point to 4.1% and growth in 2023 continues to be projected at 2.1%. Due to “a number of idiosyncratic factors, such as the end of the temporary VAT rate reduction in Germany, delayed sales periods in some euro area countries and the impact of the stronger than usual changes in HICP weights for 2021, as well as higher energy price inflation, the 2021 CPI inflation forecast was increased from 1.0% to 1.5%, but the longer term CPI projections of 1.2% in 2022 and 1.4% in 2023 were left virtually as before. Significant, inflation at the end of the policy horizon remains below target, and near-term risks surrounding the GDP growth forecast are still skewed to the downside.

In the ensuing press conference, ECB President Lagarde made several points supporting the strong commitment to keeping a very accommodative monetary stance for considerably longer. One, downside risks such as the uncertain future evolution of the pandemic, the appreciation of the euro, higher long-term interest rates, a lack of wage pressure, and considerable slack in productive resources still persist. Two, although the near-term inflation outlook has become more elevated, this change reflects temporary factors and will eventually be overtaken by the drag from being so far short of full employment. Inflation in 2023 is likely to still be about a half percentage point below inflation. And three, it would send the wrong signal to inflation expectations to start unwinding monetary stimulus now. Euroland is in a double-dip recession. After rising 0.1% in the final quarter of 2019, real GDP contracted in each of the first two quarters of 2020, rebounded last summer, but then contracted again in 4Q probably the current quarter, too. Monetary tightening could jeopardize financial conditions and longer-term price stability.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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