ECB does not pull plug on easy money and will keep stimulus as long as it is needed
The European Central Bank (ECB) raised growth and inflation forecasts for the euro area on Thursday but stuck to its pledge to provide stimulus for as long as needed, predicting inflation would remain below target into 2020.
The ECB kept its key rates on hold and also held rigidly to its script on its intentions for next year – despite pressure from some policymakers to acknowledge explicitly the strength of the euro zone recovery and more closely follow the US Federal Reserve’s tightening trend.
The euro rose to a day’s high of US$1.186 after the bank raised its growth forecasts from this year through to 2019. There was also a modest upgrade of price expectations, though inflation was predicted at just 1.7 per cent in 2020 – short of its official target of close to 2 per cent.
“All in all the revision of the macroeconomic projections is going in the right direction,” ECB President Mario Draghi told a news conference, noting that the inflation outlook was still muted and thus required “ample” stimulus.
So while growth and inflation forecasts were raised, by big margins in some cases, the ECB did not even discuss changes to its policy stance or the guidance that serve to anchor expectations.
In a nuanced message, Draghi nonetheless added that he was more confident than two months ago that the inflation target could be reached and said he saw no negative effect from tightening by the US Federal Reserve, which announced its latest rate hike on Wednesday.
Six weeks after agreeing to halve asset buys from January, the ECB reiterated its commitment to continue bond purchases at least until the end of September, and to keep reinvesting cash from maturing debt until much later to support a rebound in growth and inflation.
Having faced five years of anaemic price pressures, the ECB has deployed its entire policy arsenal, cutting rates into negative territory, giving banks cheap loans and hoovering up bonds with an unprecedented 2.55 trillion euros (US$3 trillion) of purchases.
Its work has paid off as the euro zone recovery is now well into its fifth year thanks to nine million new jobs, letting policymakers curb stimulus from next year and raising the prospect that the lavish bond buys it started in early 2015 could finally end.
But the economic run is stronger than most have expected.
The euro zone purchasing managers’ index rose to a seven-year high this month, data on Thursday showed, while Germany’s Ifo institute unveiled a surprisingly bullish forecast for the euro zone’s biggest economy.
This rapid expansion is fuelling arguments among more conservative policymakers that the ECB is moving too slowly and should be more decisive in signalling the end of quantitative easing to preserve its remaining firepower after the crisis tested its limits.
“Remember the metaphor of the euro zone being the patient on intensive care?,” ING economist Carsten Brzeski said. “The ECB has been the chief physician, getting the patient into rehab and making him walk again with monetary crutches.”
“Today, Draghi once again made clear that walking, even walking fast, without creating inflation was fine. A reasonable cure. Only once the patient is able to sprint an entire marathon will the crutches come off.”
Still, a muted reaction to the US Federal Reserve’s third rate hike this year could potentially make the ECB’s job easier in shifting its message.
This was a sign that investors were confident enough in the state of the global economy not to fear a continued, albeit very gradual, increase in the cost of borrowing dollars – the currency that underpins much of world trade.
Policy hawks in Frankfurt want Draghi to keep preparing markets for an end to asset buys sometime next year, arguing for changes in the bank’s message to set up a formal decision by midyear on ending the bond purchase scheme.
But Draghi said there was no discussion either of a formal end date for the asset purchases or cutting the direct link between inflation and bond purchases, something advocated by several influential policymakers in recent months.
They argued that the ECB should instead connect its overall policy stance to inflation, de facto cutting the emphasis on quantitative easing (QE) and making it easier to end it.
Some policymakers argue that the ECB should increase the proportion of private sector purchases by keeping those volumes steady when sovereign purchases are cut from January.
Such a shift could also take some pressure off sovereign buys as the ECB is nearing its self-imposed purchase limits in several countries.