Friday, July 5, 2013

The ECB and BOE - accomodative monetary policy is still alive and well

As we suspected, both the European Central Bank (ECB) and Bank of England went out of their way overnight to emphasise that recent increases in interest rates and expectations of tighter monetary conditions is a US-centric phenomenon.  Statements from both central banks were decidedly dovish.  It was, however, all talk with no new action from either central bank.

For his part ECB President Mario Draghi moved to forward guidance on rates, incorporating a continued bias to ease, by stating the ECB will keep rates at the current or lower level for an “extended period”.  The move away from the previous policy to “never pre-commit” was made necessary by the recent tightening in monetary conditions reflected in higher Eurozone interest rates.  At the press conference he said the extended period would be determined by the medium-term outlook for inflation, growth and credit conditions.  Draghi again highlighted the potential for lower interest rates, including the possibility of negative deposit interest rates.

It remains the case that while there has been relative calm in financial markets in Europe, it is yet to translate into higher economic growth.  Recent data, while better, is still best described as being “less bad”.  And the financial calm itself remains fragile.  Latest political ructions in Portugal could lead to fresh elections and a backlash against austerity.  In Greece the troika is meeting to discuss the next tranche of bailout funding at the same time the Greek Government wants to access some of the funding allocated for bank recapitalisations to meet its own financing gap, a result of the privatisation program being behind schedule.  Privatisation was always going to be challenging, but it means Greece is now behind in its bailout commitments.

In the UK this was Mark Carney’s first MPC as Governor.  While recent data has been better, it came just after the release of revisions to historical GDP data showing the UK economy has made less progress than previously estimated at clawing its way back to pre-GFC levels.  According to the Office of National Statistics, UK GDP is now 3.9% below its pre-GFC level compared with 2.6% previously.  That will have reinforced the dovish tone in today’s statement.

The Bank noted the recent rise in interest rates and stated the rise in rates was inconsistent with what is happening in the UK economy.  “Since the May Inflation Report, market interest rates have risen sharply internationally and asset prices have been volatile”.    And from later in the statement: “…in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy”.

While the statement was unambiguously dovish, there was no mention of specific action.  Mr Carney has only just taken charge so it was probably too early for any significant action, the minutes of the meeting, which will be released in a couple of weeks, may be more illuminating with respect to market expectations of greater use of forward guidance and/or a boost to the BoE’s asset purchase program.  Indeed today’s statement, which was more fulsome from what we would normally see from the BoE, specifically mentioned the latest remit letter from the Chancellor of the Exchequer to the MPC asking the Committee to provide an assessment in August of the case for adopting some form of forward guidance.  Watch this space.

Today statements highlight the different states-of-play for each of the US, Eurozone and UK economies with respect to growth and the outlook for inflation.  In the US, fundamentals are improving, growth is expected to pick up this year and the output gap is expected to eventually close.  At the same time the Eurozone remains in recession while in the UK, the economy is finding it difficult to generate momentum with the result a large and persistent output gap.  While there was no action from either central bank today, we would expect both to be more aggressive, especially if rates continue to head higher.  Accommodative monetary policy is still alive and well.