Friday, May 9, 2014

ECB to ease in June?

The European Central Bank (ECB) left monetary condition unchanged at its May meeting but the Governing Council (GC) is clearly concerned about the inflation outlook.  While they didn’t do anything today, dovish comments from ECB President Mario Draghi suggested the central bank was just waiting on further information before acting next month.   That new information will include updated staff forecasts, March quarter GDP data (scheduled for release on May 15) and of course there will be the next monthly readings on inflation
and credit growth.

At the press conference today Draghi stated the ECB is happy the recovery is firming up, but they are dissatisfied with the projected path of inflation.  That’s consistent with our view  that while the growth outlook is improving in the Euro area it will prove to be insufficient to make any serious dent the significant amount of spare capacity across the region which poses downside risks to inflation.  Indeed annual inflation is currently negative in five member states.

So what could they do in June?  While the ECB confirmed its unanimous commitment to using unconventional instruments within its mandate, it’s too early to expect quantitative easing.  It’s more likely we will see a cut to interest rates (a cut to the refinancing rate and a negative deposit rate).  That would most likely reverse the recent drift higher in market interest rates.  However such a move would be large symbolic as it would prove insufficient to cure what ails the Euro area, although it might be sufficient put some downward pressure on the exchange rate.

Another likely move is for the ECB to stop sterilising their 172 billion holding of sovereign bonds purchased in the Securities Markets Program (SMP) by stopping the reabsorption of the SMP cash.  That would have a similar effect to QE although it differs in the sense that the asset have already been purchased - in fact you could call it "delayed QE".

The next meeting of the Governing Council is scheduled for June 5th.