A 10-15 bps cut to the refi rate in June seems possible, provided that the ECB staff’s forecasts for the second half of this year and the beginning of 2015 confirm downward revisions to 2015-2015 inflation estimates. A cut of the deposit rate….
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into marginally negative territory cannot be ruled out, but remains unlikely, in our view. QE remains conditioned to a revision of the inflation forecast towards 1.0% in 2H 2015 and 2016, which we do not believe will be printed already
with the June scenario.
– As expected, the ECB’s May meeting brought no changes in interest rates nor in non-standard measures. The statement was almost unchanged compared to last month’s, and reasserted the ECB’s determination to “maintain a high degree of monetary accommodation, interest rates at present or lower levels for an extended period of time”, and to “act swiftly if needed”. The ECB also confirmed that “the Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation”, as it stated in April.
– During the press conference, Draghi specified that the Council did not discuss any interventions, but focused on the evolution of risks to the growth and inflation scenario. The debate, in some ways, was preparatory ahead of the June meeting. Draghi, however, indicated that there was a consensus within the Council about being dissatisfied with the projected path of inflation and that this is a prerequisite for introducing new monetary stimulus in June, if justified by ECB the staff estimates (still not completed).
– Draghi repeatedly tried to talk down the EUR stating that the exchange rate is now reason for concern for price stability in the medium term and that it is now exerting downward pressure on the inflation profile, especially in the current “context of low inflation” and modest and fragile growth. The statements compressed the EUR back to 1.3857 from 1.394 the start of the press conference. Draghi refused to indicate a tolerance threshold, but the ECB’s March scenario included simulations on the impact of a 3% appreciation of the euro (to 1.398-1.40) compared to the technical assumption of an exchange rate at 1.36 on the forecasting horizon.
The resulting effect on growth and inflation was indicated as being rather modest, of 0.1-0.2%. Draghi said that the strength of the euro is due to incoming portfolio flows as a result of risk reallocation at the global level.
– As regards the assessment of the macroeconomic scenario, the ECB considers risks to growth to be skewed to the downside, pointing out in particular the geopolitical risks associated with the Ukraine-Russia crisis. Risks to the inflation path are considered as balanced, although Draghi expressed his belief that said stubbornly very low inflation will increase the risk of medium-term expectations being de-anchored.
– In our view, in June the ECB will revise its inflation forecast for 2015-16 only marginally, to justify a potential 10-15 bps refi rate cut, and in to leave the door open for further moves in the second half of 2014. We still consider a cut of the deposit rate into slightly negative territory as unlikely, but we are not ruling it out, as Coene said that actions on policy rates generally have a much stronger impact on the money market if the fluctuation corridor is shifted symmetrically”. A cut to deposit rate into negative territory could support a correction of the exchange rate. Should May inflation data surprise on the downside and/or PMIs turn back downwards, we believe the probability of a cut would increase to significantly above 50%. As we have said repeatedly in past months, a refi rate cut would have mostly signalling effect, with no particularly significant impact on market rates and on medium-term inflation expectations. Its effectiveness would be tied to its fuelling expectations for more radical measures in the future.
– A quantitative easing programme implying widespread asset purchases (reasonably both public and private) would effectively have a strong impact on market rates and on inflation expectations, but was not mentioned at the meeting of 8 May. Probably, sufficient consensus still hasn’t gelled within the ECB’s Governing Council to act to prevent the risk of inflation staying too low for two long; action in this direction would probably only be prompted by surprises from economic data over the summer months, justifying a revision of inflation forecasts to 1.0% in the second half of 2015 and 2016 as well.
Appendix
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