Friday, 05 July 2013

ECB Promises Easy Rate Policy To Remain For Extended Period

No change in ECB rates, but surprise commitment to maintain rates very low. Draghi promises rates will remain at present or lower levels for an extended period of time. Extended period should be seen in terms of economic data rather than calendar dates, but suggests no tightening until late 2014/2015. Forward guidance is a major change in ECB approach and amounts to a verbal easing. Possibility of further rate cut remains but requires much weaker economy.

MarketsdidnotexpectanychangeinkeyECBinterest ratestodayandinthatrespecttheywerenotsurprised. However,marketswerealsobracedforaratherdull pressconferencefromECBpresidentMarioDraghiandin thatregard,MrDraghispronouncementscameas somethingofashock.Hisremarkskeepalivethe possibilityofafurthereasingand,moreimportantly,in aradicaldeparturehesuggestednolikelihoodof tighteningofpolicyfortheforeseeablefuture. MrDraghistruckanotablymoredovishtonethanmight havebeenexpectedtodayparticularlyinlightof tentativesignsofalimitedimprovementintheEuroarea economyoflateaswellasuptickininflationlastmonth to1.6%,areadingthatputsitbroadlyinlinewiththe ECBstargetofbelowbutcloseto2%.MrDraghitook theunprecedentedstepofcommittingECBpolicyrates toremainatpresentorlowerlevelsforanextended periodoftime.Althoughwepreviouslysuggestedthat thecommitmenttokeeppolicyaccommodativeforas longasneededfirstmadeinMarchrepresenteda

tentativesteptowardsameasureofforwardguidance, todaysannouncementisanaltogethermoreexplicitand bolderdeparturefromtheECBspreviousmantraofwe neverprecommit. TodaysECBpressstatementalsoprovidessignificant guidanceastowhatanextendedperiodmightprove tobeinpractice.Itisclearthateconomicdatarather thancalendardateswilldeterminewhenpolicy changes.Thatsaid,todayscommitmentimpliesthere shouldbenoconcernabouthigherpolicyratesfora considerabletime.TheECBpressstatementindicates thattheECBsexpectationofanextendedperiodof accommodativepolicyisbasedontheoverallsubdued outlookforinflationextendingintothemediumterm, giventhebroadbasedweaknessintherealeconomyand subduedmonetarydynamics.Byclearlylinkingitspolicy stancetoeconomicconditionsandtoinflation prospectsinparticular,theECBhopestolimitanythreat toitscredibilityfromtodaysaction.Inlightoflast monthsECBprojectionsfor2014thatshowsubdued
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inflation(circa+1.3%)andlacklustreactivity(GDPgrowth of+1.1%),onlytheprospectofadramaticacceleration ininflationand/oractivityin2015wouldsuggestany riskoftighteninginpolicywithinthenexttwoyears.Mr Draghiunderpinnedsuchexpectationsbyemphasising todaythatanexitfromcurrentaccommodativepolicy settingsremainedverydistant.

ForwardGuidance

= A Verbal Easing

How Threatening Are Recent Market Developments?

MrDraghialsosaidtherehadbeenanextensive discussionofapossibleratecuttodayarather surprisingdisclosuregiventherathermoreupbeattone ofhiscommentsamonthago.Instead,hemayhave referredtothisinordertoemphasise'adownwardbias' topolicy.Wefinditdifficulttoimaginethatacuttoday wasaseriouspossibilitygivenMrDraghis acknowledgementthattheECBsbaselinescenarioofa gradualrecoveryseemsconfirmed.Henotedarguments advancedforafurthereasingincludedsometighteningin monetaryconditionsandweakmonetarydevelopments oflate.Indeed,todaysECBpressstatementhighlighted therecenttighteningofglobalmonetaryandfinancial marketconditionsandrelateduncertaintieshavethe potentialtonegativelyaffecteconomicconditions. Asdiagram1belowindicates,recenttrendsinfinancial marketconditionsasseeninthetradeweighted exchangerateoftheEuro,expectationsforinterbank ratesinlate2014and2015antthebehaviourofbond yieldseitherinthecore(asrepresentedbyGermany)or theperiphery(asrepresentedbySpain)don'tappearto havemovedontoaparticularlythreateningtrajectoryin thepastmonth.Neitherisrecentweaknessincredit growthanewtrend.Atthemargin,recent developmentsinfinancialmarketsmightposesome downsiderisktowhatisafragilerecoveryanditmaybe thattheECBwantstolimitsuchthreatsinsofaras possible.However,wedontthinkthisadequately explainstodaysannouncement.

Weremainoftheviewthatonlyasignificant deteriorationineconomicconditionswouldpromptthe ECBtocutitskeypolicyratesfurther.Inmanyways todaysforwardguidancecanberegardedasa substituteforfurthereasingasitshouldinfluencethe behaviourofbusinessesandhouseholdsaswellas alteringmarketexpectations.WhileMrDraghi emphasisedthattheECBstillhadabiastoeaseandthis includesthepossibilityofmovingtoanegativedeposit rate,wethinksuchactionswouldtaketheECBinto dangerouslyunchartedterritoryandwouldonlyarisein direcircumstances. Todaysannouncementmayreflectaviewthat preventionisbetterthancureasfarascontinuing downsideriskstoactivityareconcerned.The commitmenttoanextendedperiodofeasingpolicy emphasisestheECBsintentiontonurturethetentative improvementineconomicconditionsseenoflate.Itis alsointendedtoclearlypreventmarketsmovinginan unhelpfuldirectionbyindicatingthatthebiasinECB policyistowardsafurthereasingratherthanany removalofaccommodation.

What Prompted Todays Announcement?

Wefinditdifficulttorelatethepolicycommitment givenbytheECBtodaytodevelopmentsintheEuro areaeconomyinthepastmonth.MrDraghialludedto anassessmentofinflationinthemediumtermthat justifiesthenewcommunicationbuthedidntdetail whatthismightbealthoughhedidhighlighttherecent tighteninginmonetaryconditions.Asnotedabove,we dontthinkthisrepresentsacompellingargumentfor todaysannouncement. Instead,wecanthinkoffourpossibleoverlapping argumentsthatcanbemadefortodaysECBpolicy guidance;(1)itcouldbethattheECBwantsto emphasisethatitisatadifferentphaseinthepolicy cycletotheUSFederalReserve,(2)itmaybethatthe ECBisworriedthataperiodofheightenedvolatilityin financialmarketscouldundermineatentative stabilisationintheEuroareaeconomy,(3)theECBmay feelaneedtomodifyitscommunicationstrategyto counterheighteneduncertaintyatpresent,andfinally, (4)itcouldhavedecidedonthebasisofaanassessment oftheeconomicoutlookanditsratherlimitedpolicy optionsthattherisksofalostdecadefortheEuroarea requireittopursueasomewhatboldermonetarypolicy
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strategyandforwardguidancerepresentstheeasiest waytoimplementthiswithoutthreateningitsmandate. Thesevariousconsiderationsarenotmutuallyexclusive buttheylikelyrankdifferentlyintheassessmentsofthe variousmembersoftheECBsGoverningCouncil. However,becausearangeoffactorspointinthesame direction,MrDraghiwasabletoemphasiseona numberofoccasionstheunanimousnatureoftodays decisiontogiveacommitmenttomaintain accommodativemonetarypolicyforanextended period.

capacitytorespondtodownsiderisks.Thishasledtoa significantamountofvolatilityaroundtheECBsmonthly meetingandincreaseduncertaintyaboutitsintentions alessthanidealoutcomeforaCentralBankthat emphasisesthemediumtermnatureofitspolicyfocus.

Mr Draghi May Now Hope To Be Dull

Unfortunately,increasedvolatilitymaybetheinevitable consequenceofasignificantworkinprogressinavery uncertainenvironment.TodaysunexpectedECB decisiontoprovideasignificantamountofforward guidanceshouldprovidenotablygreaterclarityabout thestanceofECBpolicymakingthroughthenextyear toeighteenmonthsandmayacttocountertheimpact ofincreasedvolatilityfromothersources. MrDraghiemphasisedtodaythattheECBseesitsmain taskthroughtheperiodasunderpinningarecoveryinthe Euroareaeconomy.Bysayingthatkeypolicyrateswill remainatpresentorlowerlevelstheintentionisto boostconfidenceintherealeconomyaswellaslimit anytighteninginmonetaryconditionsthatmightfollow fromdevelopmentsoutsidetheEuroarea.By implementingwhatamountstoaverbaleasingtoday, theECBmayhopetoreducedownsideriskstothe outlookandtherebylimitthelikelihoodthatitwillneed totakeanyfurtheraction.Ifthisworks,weshouldlook forwardtonotablydullerECBmeetingsforsome considerabletime AustinHughes,KBCDublin PietLammens,KBCBrussels
.

Past Six Months Have Been Noisy For ECB

Wewouldbesurprisedanddisappointediftodays announcementreflectsareflexresponsetothevolatility causedbytheFederalReservesrecentannouncementof itsintentiontostarttaperingitsassetpurchase programme.Instead,wethinkthattodays announcementlikelyowesmuchtoadetailed assessmentofthehealthoftheEurozoneeconomyand ofthediminishingnumberofinstrumentsavailableto theECBtosupportarecovery.Limitationsimposedby theECBsmandateanddifferencesinviewsaroundthe GoverningCounciltablehavecomplicatedthiswork. ThroughthepastsixtoninemonthstheEuroarea economyhasgenerallyappearedfairlyweakwhile inflationhaseasedmarkedly.Frequently,throughthis periodthetrajectoryofactivityandpriceshaslooked dangerouslyweak.Anunderstandabletendencytoreact andpossiblyevenoveracttosmallchangesineconomic conditionsseemstohavecoincidedwithaperiodof intenseworkintohowtheECBmightincreaseitslimited

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Contacts
BrusselsResearch(KBC) PietLammens PeterWuyts JokeMertens MathiasvanderJeugt DublinResearch AustinHughes ShawnBritton PragueResearch(CSOB) JanCermak JanBures PetrBaca BratislavaResearch(CSOB) MarekGabris WarsawResearch BudapestResearch DavidNemeth
ALLOURREPORTSAREAVAILABLEONWWW.KBCCORPORATES.COM/RESEARCH
Thisnonexhaustiveinformationisbasedonshorttermforecastsforexpecteddevelopmentsonthefinancialmarkets.KBCBankcannotguarantee thattheseforecastswillmaterializeandcannotbeheldliableinanywayfordirectorconsequentiallossarisingfromanyuseofthisdocumentorits content.Thedocumentisnotintendedaspersonalizedinvestmentadviceanddoesnotconstitutearecommendationtobuy,sellorholdinvestments describedherein.AlthoughinformationhasbeenobtainedfromandisbaseduponsourcesKBCbelievestobereliable,KBCdoesnotguaranteethe accuracyofthisinformation,whichmaybeincompleteorcondensed.AllopinionsandestimatesconstituteaKBCjudgmentasofthedataofthe reportandaresubjecttochangewithoutnotice.

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