The ECB also extended the full allotment regime on marginal, one-month, and three-month refinancing operations until 7 July 2015. The ECB confirmed its forward guidance and easing bias on policy rates…..
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We believe the decision to extend full allotment, rather than the refi cut, will have an effect on money market rates and on financial conditions in the euro area, as it makes a tightening of monetary policy rather unlikely before the summer of 2015.
The ECB cut the refi rate by 25 basis points to 0.25%, and the marginal lending rate to 0.75%.
The deposit rate was left unchanged at 0.0%. The ECB has also extended until 7 July 2015 the full allotment regime on the main refinancing operations, and on 1m and 3m refinancing auctions. One-month operations will be settled at the current rate on marginal refinancing operations in the month, whereas the three-month auctions will be settled at the prevailing average rate during the life of the operation. Many analysts thought the ECB may have announced three-month operations (or longer term auctions) at a fixed, and no longer variable rate, so as to impress a downward thrust on money market rates. The ECB also confirmed forward guidance and its easing bias on policy rates. During the press conference, Draghi specified that all the members of the Council agreed on the need to act on monetary policy, but not all were in favour of a cut already at the November meeting. On the other hand, the decision to confirm forward guidance was unanimous.
The decision to intervene was prompted by surprisingly low inflation in October (down to 0.7% from a previous rate of 1.1%, vs. prevailing consensus for an unchanged rate), and by the expectation that inflation will stay low, significantly below the 2% mark, for an “extended” period of time. The ECB will shed light on how long that period will be with its December estimates. We expect the new forecasts for 2015 to set euro area inflation at 1.3/1.4%. Also, the ECB may revise downwards its estimates for 2014, to below 1.3%. In the ECB’s assessment, the slowdown in inflation is widespread to the entire area, and to several spending items: services, food & beverages, energy, and non-energy industrial goods.
Draghi clearly stated that the exchange rate did not play any role in the discussion this month, although he once again repeated that “it remains important for our price stability objective”.
However, the most beneficial effects of yesterday’s move may well be felt by the exchange rate dynamic, which in 2014 could be accentuated by the Fed’s monetary policy moves.
The ECB explained its easing bias on rates also in the wake of the decisions taken at the November meeting, and despite soundly anchored medium-term inflation expectations. The ECB targets an inflation rate lower than 2% but close to that level, taking into account the fact that with an inflation rate of close to zero, the convergence process within the euro area becomes more difficult, and monetary policy less effective.
Most analysts were taken by surprise; the sharp reaction shown by the exchange rate and by market yields proves that the prevailing view on the market was that the November meeting would have been an interlocutory one. Draghi also said that the rate cut is not in contrast with the indication, included in October forward guidance, of interest rates at their “present or lower levels for an extended period of time”; the ECB President added that since then the inflation outlook has changed, prompting the decision to lower rates, rather than to leave them unchanged.
Draghi noted that the ECB’s communication was effective in reducing the excessive volatility of the EONIA rate. Draghi expects volatility to decrease further following the November cut, as the corridor has narrowed and is asymmetrical.
Draghi specified that the ECB has not run out of ammo, that the refi rate may drop further, and that a deposit rate cut should not be ruled out. Draghi confirmed openness to new refinancing operations, while stressing that for the time being the drop in excess reserves to 185 billion euros has not impacted money market conditions, and this is because market conditions are now closer to normal. Draghi pointed out that the latest Bank Lending Survey signalled that cost of funding, and difficult access to the market, were no longer factors weighing on the decision to make credit conditions more tight. For time being, therefore, Draghi does not consider it urgent to announce new longer-term refinancing operations. However, he did indicate that the reduction in interbank market fragmentation seems to have remained unchanged in the past few months.
In our view, barring clear signals of a further drop in inflation, or serious setbacks in the “fragile” recovery of the economic cycle, policy rates will be left unchanged in the next few months. As regards non-standard measures, we stick to our view that in the coming months the ECB may announce the date of another longer-term refinancing operation, geared to smoothing the repayment of the liquidity injected with the two 36-month LTROs, but with a shorter duration, no longer than three years. However, current market conditions impose no urgency on the announcement.
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