The ECB unsheathes its credible threat in OMT style, stating that the Council unanimously agrees on the option of implementing quantitative stimulus in case of negative surprises from growth and inflation. If the economy evolves as…
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expected, the weapon will not be used. However, if data surprise negatively, the ECB could initiate a crescendo of measures, ultimately launching am asset purchase programme.
– As expected, at its meeting of 3 April the ECB adopted no tangible monetary policy measures. In the past month, economic data confirmed the gradual recovery under way in the euro area, and while inflation is very low, it is still at levels compatible with medium-term staff forecasts, and medium-term expectations remain well-anchored. This time, however, communication succeeded in moving financial variables in accordance with the monetary policy stance. Specifically, the April statement confirmed forward guidance, while adding 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”. Furthermore, Draghi specified that the Council also discussed a quantitative easing (QE) programme, that had not been debated up to last month. In addition, the ECB discussed the possibility of launching a new LTRO (to face liquidity shortages), an LTRO conditioned to the issue of credit, and the suspension of SMP sterilisation.
– Draghi warned that QE in the euro area should be carefully designed, as a stimulus programme comparable to the Fed’s would not be as effective in the euro area. The main effect of the Fed’s QE was to trigger a portfolio reallocation towards riskier asset classes, resulting in a reduction of the term premium and of credit risk. In Europe, however, about 80% of the funding to the economy still takes place through the banking system. A programme for the purchase of bank assets packaged as ABS would therefore be the most appropriate instrument, but implementation difficulties prevented openness from translating into tangible plans. In case of need, therefore, the ECB would not be able to avoid the purchase of government bonds, counting on the fact that this would have effects on the exchange rate and on confidence. As repeatedly rumoured, the ECB could purchase assets issued by all euro area countries, including Germany, up to a set amount proportional to the share held in the ECB’s capital by the individual member states.
– The outcome of the April meeting has much in common with the announcement of OMTs in the summer of 2012. The ECB draws a weapon a leaves it to the market to assess whether or not it is loaded and if it intends to use it or not. At the same time, however, its behaviour discourages anybody from questioning the credibility of the threat. Whether the ECB will act or not will to all effects depend on the evolution of the growth and inflation outlooks. For the time being, the Council does not consider the risk of deflation to have increased: the March inflation figure is still considered as too preliminary and too strongly conditioned by base effects and temporary factors to prompt a review of the inflation outlook. On the whole, the ECB considers risks to the consumer price trend as still balanced. If forecasts are correct, the weapon will be reholstered unused. However, if growth and inflation data in April and May surprise negatively, the ECB could out in place a crescendo of measures: 1) refi rate cut; 2) suspension of the SMP and/or announcement of a new LTRO (possibly conditional on lending, although there is uncertainty on what the reception would be); 3) initiation of a quantitative stimulus programme, probably mostly focused on government bond purchases. As regards timing, any negative indications from April and May data could prompt the ECB to act in July, after having exhausted its other measures. By that date, the ECB would have a full picture of economic performance in the first half of the year, and a clearer idea of the prospects for the second half, as well as new growth estimates for 2015-2016.
Appendix
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