ECB View: GC watching side effects but confident it is not yet at reversal rate – The account of the December Governing Council meeting signalled that officials saw: 1. Some positive signs on the growth and inflation front and with regards to the risk spectrum; 2. Despite these, the outlook was still not satisfactory and risks were still on balance to the downside; 3. It remained ready to ease policy again if necessary; 4. Although it was watching side effects of its policies, it was not too concerned about these, and saw policy as being a net positive for banks and the economy. Below we set out these points in more detail.
Some positive signs – Chief Economist Philip Lane noted that ‘incoming data since the last monetary policy meeting pointed to continued weak but stabilising euro area growth dynamics’. At the same time ‘risks had become somewhat less pronounced’. In addition, indicators of core inflation that excluded package holidays had suggested ‘a very gradual but notable upward slope in the path of underlying inflation over recent years’. On a less positive note, ‘other measures showed a less convincing upward trajectory’ and ‘wage growth remained resilient but stronger labour cost pressures had been largely absorbed by profit margins’.
Outlook not satisfactory – Nevertheless, the GC still judged that ‘risks to the growth outlook remained tilted to the downside’ as although ‘trade tensions between the United States and China were diminishing…the global geopolitical situation was not conducive to lowering uncertainty, at least in the short term’. Ultimately, ‘the Governing Council was still faced with an inflation outlook that was below its medium-term aim, and inflation expectations continued to stand at low levels’.
Further action still possible – ‘The Governing Council would, therefore, closely monitor inflation developments and the impact of the unfolding monetary policy measures on the economy’ and it ‘stood ready to adjust all of its instruments, as appropriate, to ensure that inflation moved towards the aim in a sustained manner, in line with its commitment to symmetry’.
Side effects – ‘Some members highlighted the need to be attentive to the possible side effects of the present monetary policy measures, which merited close monitoring in the period ahead. It was suggested that the liquidity created by the Eurosystem needed to be tracked carefully regarding its impact on bank intermediation and asset markets – namely equities, housing and real estate – as well as capital outflows outside Europe in a search for yield. Some concern was also voiced with regard to the potential impact of negative interest rates on euro area households, with savings and consumption dynamics also requiring close monitoring’.
Not at reversal rate – Nevertheless the GC expressed confidence that ‘policy rates had not yet reached the so-called reversal rate’. This reflected ‘ample evidence that credit conditions in the euro area had continued to improve’ and that ‘the overall effects on bank profitability had remained positive. This related in particular to capital gains from banks’ sales of securities to the Eurosystem and lower provisions for loan impairment, with the overall macroeconomic environment having improved in part as a consequence of the accommodative monetary policy stance’. Finally ‘macroprudential policies were the first line of defence for addressing risks and side effects, as they could be tailored to the issues identified’.
Our own view – Overall, the tone of the account is somewhat more positive, but we still expect the ECB to ease monetary policy further in the coming months. Economic growth is likely to remain weak in the next few months and we think underlying inflationary pressures will soften further. Furthermore, the starting point is an unsatisfactory inflation outlook. We expect a 10bp deposit rate cut, an increase in net asset purchases to EUR 40bn a month and a further increase in the maturity of the upcoming TLTRO tranches. Our base case is that this package will be announced at the March Governing Council meeting, though the risks are skewed towards a somewhat later announcement. (Nick Kounis & Aline Schuiling)