By Alan McQuaid
The ECB held its penultimate monetary policy meeting of 2018 last week.
Making for a colourful backdrop were growing concerns about the impact of trade tensions on the economic outlook, budgetary problems in Italy, fraught Brexit talks, and volatility in world financial markets.
The ECB kept policy unchanged as expected, staying on track to end bond purchases this year and raise interest rates next autumn, even as it warned that risks from protectionism were gaining prominence.
With inflation rebounding and growth levelling off at a relatively healthy pace, the ECB has been gently removing stimulus for months in the belief that a range of risks from trade disputes to emerging market turbulence and Brexit will not be enough to derail an economic expansion now in its sixth year.
Making only nuanced tweaks in its policy statement, ECB chief Mario Draghi nevertheless acknowledged in his press conference that the growth outlook has worsened as both domestic and external factors weigh on confidence, though again saying that the risks to the eurozone economy remain broadly balanced.
It maintained its stance that bond-buys are expected to end by the close of the year and that interest rates will stay unchanged at least through next summer or for as long as necessary to ensure price stability in euroland.
While this is seen as an unusually long guidance period for a central bank, it has been uncontroversial and is fully priced in by financial markets.
The ECB has kept interest rates in negative territory for years and bought more than €2.5tn of debt, depressing borrowing costs and driving up growth following a double-dip recession that nearly tore the 19-member currency bloc apart.
Still, the focus is now starting to turn to when exactly the ECB will start raising rates.
Dutch central bank governor Klaas Knot said earlier this month that the ECB will in January have to start discussing the lift-off for a rate increase.
Mr Draghi also stirred the rate debate with his recent reference to a “relatively vigorous” rise in underlying inflation — comments that have been toned down since.
At the same time, market turmoil in Italy has ignited caution into investors’ rate-hike expectations.
Since the ECB’s September meeting, Italy’s anti-establishment government has delivered an expansionary budget, sparking a clash with the EU and sending Italian bond yields up sharply.
The bond sell-off has rippled into Italian banking stocks, broader share markets, and the euro.
Correlations between euro-dollar and the German-Italian bond yield spread have strengthened, highlighting the currency’s sensitivity to Italian bonds.
Mr Draghi said this month that Italian officials must stop questioning the euro and need to “calm down” in their budget debate as they have already hurt firms and households.
He again acknowledged the risks from emerging markets, such as China, Turkey, and Argentina.
Partly reflecting those risks, the ECB cut its growth projection by a 0.1 percentage point for the next two years at its September meeting.
Mr Draghi argued that growth would slowly ease as stimulus waned and growth returned to its natural state.
He added that major central banks curbing their support was also a source of risk that could increase market volatility.
In another ominous sign, the ECB also last month cut its underlying inflation forecasts for next year and 2020 while maintaining its overall price growth forecast, suggesting that fundamental price pressures are not building as fast as it had hoped.
Following the October decision, the ECB’s deposit rate, currently its primary interest rate tool, remains at minus 0.4% while the main refinancing rate, which determines the cost of credit in the economy, stays at zero.
In my view, Mr Draghi is a cautious man, who would rather be safe than sorry, and as such won’t want to repeat the mistake of his predecessor Jean-Claude Trichet and raise rates too early.
Mr Draghi will forever want to be remembered for that July 2012 speech in London of “doing whatever it takes to save the euro”, which he duly delivered on, rather than for again prematurely hiking rates and causing another downturn.
Therefore, I wouldn’t be at all surprised to see the Italian ending his eight-year term as president, on October 31, 2019, without having overseen a rate increase.
This implies that a hike won’t come until December next year at the earliest, as there is no scheduled policy meeting in November, and even then it may only be the deposit rate that is raised.
So in effect, I think it won’t be until 2020 that Irish consumers are hit with an increase in ECB interest rates.
Alan McQuaid is chief economist at Merrion Capital