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ECB: the policy of small steps

The ECB made no dramatic announcements on Thursday 9 March, but it continues to move slowly toward less monetary accommodation. While reiterating that "[a] very substantial degree of monetary accommodation is still needed," it no longer makes any reference to the fact that it could "use all the instruments available within its mandate" to achieve its aim. Mario Draghi explained that the urgency had faded. Moreover, GDP growth forecasts have been adjusted upward, and the ECB deems that the risks in terms of economic outlook are “less pronounced”.

Important point: even though Draghi recognized that the subject had been debated at the Governing Council, forward guidance (interest rates "to remain at present or lower levels for an extended period of time") was unchanged. It bears repeating that Yves Mersch said on 10 February that it was becoming more and more complicated to leave it in his communication that key interest rates could still be lowered and had spoken out for urgently making the "necessary [...] adjustments" in terms of forward guidance.

The negative effects of unconventional monetary policies are more and more frequently espoused by certain governors and a number of politicians particularly German ones (see Wolfgang Schäuble this week). (For the Germans, the QE was justified by the risk of deflation, which is no longer prevalent today).  This discontent is understandable:

  • German banking federation has declared that the extremely low interest rate policy was creating difficulties for German banks, which have very large excess reserves. Yet holding deposits costs money, because liquidities deposited at the ECB are taxed at 0.4%. The negative deposit rate policy has costed German banks 1 bn € in 2016.
  • The ECB’s low-interest-rate policy lowers the returns on savings. This topic is very sensitive in Germany, which must contend with financing pensions and its ageing population.
  • In 2016, the Bundesbank's distributable profit sank to its lowest level since 2003, at €0.4 bn, while the size of its balance sheet shot up to €1393 bn

Despite its renewed optimism, the ECB remains cautious:

It is still waiting for core inflation to rise. While headline inflation met the 2% target for the first time since January 2013, this is an illusory acceleration of inflation, because core inflation, which is a better reflection of inflationary pressures at work, is still not showing any sign of accelerating (just +0.9%). By the way, the ECB has raised its core inflation forecasts for 2018 (1.5%) and 2019 (1.8%).

In addition, economic gaps still yawn wide among the different eurozone countries. The situations on the labour markets are quite mixed. The differences in phases of the cycle also result in different trends in bank loans to businesses. While there is a slight acceleration in Germany (+3.6% in January) and France (+4.8%), credit distribution to non-financials corporations is still sluggish in Europe's southern countries (Italy: +1%, Spain: -0.8%).

The ECB is also being cautious about the upcoming electoral deadlines in the eurozone and cannot rush: sovereign spreads have widened since the start of the year for virtually all countries. On this subject, Mario Draghi explained that it was difficult to assess the economic impact of certain political events. A few electoral dates will probably come and go before the ECB decides to accelerate this movement.

The idea of a gradual reduction in monetary accommodation by the ECB will drive long-term rates higher in 2017.








AINOUZ Valentine , CFA, Credit Strategy
DRUT Bastien , Fixed Income and FX Strategy
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ECB: the policy of small steps
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