- Comments from officials suggest that the ECB is considering a package of measures in December…
- …these could include steps to encourage bank SME lending, as well as clearer forward guidance
- Risk of a refi rate cut has risen, while a deposit rate cut could be employed if deflation loomed
- Meanwhile, China’s new loan growth slows in line with more prudent monetary policy
Reports of a December package from the ECB
The news agency – Market News International – reported comments from a number of ECB officials, which give an interesting insight in to the Governing Council’s deliberations at last week’s meeting. According to the reports (which also appeared in the Financial Times) six Governing Council members were against the November rate cut. For some it was a question of timing (as suggested by President Mario Draghi) though for others the opposition was apparently more fundamental. According to the officials, a rate cut had been debated by the Governing Council over the last few months, but no action was taken because of opposition from some members. But given the inflation backdrop, Mr Draghi decided in November that the Council could no longer wait for unanimity. Finally, the officials hinted that the central bank was working on a package of measures that could be announced next month. These included policies – taken together with the European Commission and European Investment Bank – to encourage bank lending to SMEs. Though there is no detail on what these might be.
Options to get inflation back to price stability goal
Some commentators have dismissed both the November rate cut and other policies it may employ in the future as being pointless. We think this is too pessimistic a view, as surely it’s better to do something than nothing. For starters, it makes a statement that the ECB takes its inflation goal seriously and hence can help stabilise inflation expectations. Second, by reducing the market’s expectations of interest rates in the future, it eases financial conditions and puts downward pressure on the euro. This helps to support the economic recovery. In addition, the strength of the euro has helped to push down inflation via import prices (see chart) so reversing it will remove a significant disinflationary force. The central bank has options to achieve lower rate expectations. We think the next step – likely also in December – will be to strengthen its forward guidance. A possibility after that will be to reduce its refi rate towards zero. Finally, if deflationary risks intensify, it could cut its deposit rate into significantly negative territory, as it attempts keep real interest rates low. Overall, we judge the ECB does have the ammunition, and November’s move suggests it is ready to employ the necessary tools.
China loan growth adjusts to government’s aim of a more sustainable growth
Turning to China, total social financing, a broad measure of loans, fell to RMB 856bn in October, compared to 1.4 trn in the previous month. New loans fell sharply to RMB 506bn from 787bn the previous month. This is due to a general slowdown of loans to households, small businesses and corporates. The slowdown in loan activity is a sign of the central bank’s more prudent monetary policy as well as the authorities’ goal of reducing excessive credit growth in the less regulated shadow banking sector. In the past few months the central bank has been trying to refrain from liquidity injections. They have, however, had to rethink this approach on two occasions, given the sharp rise in the seven-day repo rates that followed. We think that in the coming time we will see a small shift towards monetary tightening in order to sterilize the capital inflows that have been increasing this year. China, together with South Korea, weathered the summer turmoil that hit emerging markets well. China’s currency appreciated and foreign reserves received a strong impulse. Rising property prices and an increasing trend in inflation are also supportive of more prudent monetary policy.