The European Central Bank left its policy stance unchanged as expected on Thursday, keeping a rate hike later this year on the table even as the euro zone economy suffers its biggest slowdown in half a decade.
Having ended a landmark €2.6 trillion bond purchase scheme just weeks ago, the ECB said it still expected to keep interest rates at record lows “through” the summer, sticking with its long-standing guidance even though markets now see a much later move.
But ECB president Mario Draghi may still acknowledge a sharp slowdown in economic growth, raising the prospect that any further policy normalisation could be delayed and suggesting that the bank's next move might even be an easing of policy rather than a tightening.
Germany, France and Italy, the euro zone's biggest economies, barely grew in the fourth quarter of 2018 and survey data showed on Thursday business activity across the euro zone expanded at the slowest pace since 2013 at the start of this year.
With much of its firepower depleted, Mr Draghi will use his few remaining tools sparingly, suggesting Thursday’s news conference, will be more about words of comfort rather than action.
At most, Mr Draghi may emphasise the danger that the economy slows further by saying the balance of risk is tilted to the downside. He could also provide clues about new loans to banks, called Long-Term Refinancing Operations or LTROs, likely to come in the spring.
But some policymakers have in the past objected to changing the risk assessment since such a move would naturally raise expectations of policy action and the ECB is not yet prepared for such a move and certainly not weeks after ending its biggest stimulus scheme.
A guidance tweak not accompanied by a policy move would create an impression that policy is not in sync with policymakers’ assessment of the economy.
Investors now see a rate hike only in mid-2020 while a Reuters poll of economists predicted the first rise in nearly a decade in the fourth quarter.
Temporary
Mr Draghi’s big headache is that a growth dip, seen as temporary just a few months ago, shows few signs of going away.
Manufacturing contracted near the end of 2018, export growth slowed and PMI data out on Thursday once again disappointed.
A predicted rise in underlying inflation has also failed to materialise and employment growth is slowing, a worrying sign for wages and inflation.
All this suggests that the euro zone is now growing at or even below trend, so inflationary pressures may take longer to build - testing the credibility of the ECB, which has undershot its price growth target since early 2013.
Some of the weakness may be temporary, like the struggles of the German auto industry to adjust to new emissions standards, investor caution ahead of Brexit or the drag on sentiment from protests against French president Emmanuel Macron.
But sluggish external demand is likely to be more persistent, with China’s economic struggles likely to exacerbate the slowdown.
If such a drag on growth persists, the ECB will be pressed to signal record low rates for even longer, providing more stimulus by delaying a hike.
It could also offer long-term loans to banks on more generous terms and may tweak its guidance on how long it plans to invest cash from maturing bonds back into the market.
Policymakers can afford to wait before taking more concrete steps, hoping for growth to pick up in the coming months and letting markets do its work for now by shifting rate hike expectations as data disappoint.
Investors now see a hike only in mid-2020, keeping borrowing costs low, even without explicit commentary from the ECB.
With Thursday’s decision, the ECB’s deposit rate, now its main benchmark, remains at -0.40 per cent while the main refinancing rate, its key rate during normal times, stands at 0.00 per cent. – Reuters
