The governing council reaffirmed its forward guidance on interest rates (ie that it expects official interest rates to “remain at present or lower levels for an extended period of time”).
The post-meeting statement from the ECB noted that the governing council will “remain particularly attentive to developments” in money market conditions. It indicated that it is “ready to consider all available instruments” to calm money market pressures. In the lead up to the meeting there had been some speculation that further long-term refinancing operations could occur before year-end, as the ECB looks to ease pressure on rates and maintain adequate liquidity in the eurozone.
On the issue of interest rates, ECB president Mario Draghi confirmed there had once again been a discussion on cutting rates. He stated some governors were of the view that the improvements in the economy would not justify this discussion, while other governors observed that the interest rate discussion was warranted. In the end, the council decided to leave rates unchanged.
That the council discussed interest rate policy, but once again refrained from changing it, combined with the fact that some members of the council think discussing a rate cut is no longer merited given the improving economic backdrop, lessens the chances of a further rate cut from the ECB.
Indeed, since the last rate cut in May, the eurozone has had a recovery in activity, albeit at a modest pace. The economy emerged from an 18-month-long recession, when GDP rose by 0.3% in the second quarter, representing the first increase since the third quarter of 2011.
Leading indicators of economic activity suggest that the recovery in activity continued in the third quarter. The eurozone’s composite PMI, a good lead indicator, increased to 52.2 in September, a 27-month high. For the third quarter as a whole, the PMI average of 51.4 is well up from the second quarter average of 47.8.
Another important lead indicator of activity, the European Commission’s economic sentiment index, has picked up strongly in the third quarter.
Meanwhile, the key German Ifo and French INSEE business sentiment indices have also been on a rising trend in recent months. The continued rise in the various leading activity indicators over the summer months suggests that the pick-up in the economy is gaining momentum.
However, downside risks to the economic outlook persist, with the economy still facing considerable headwinds. The ongoing deleveraging in the private sector, further fiscal tightening, restrictive credit conditions and high unemployment, are likely to restrain the pace of economic growth. Thus, the recovery is fragile, as evidenced by the weak data for July, which saw a sharp fall in industrial production.
The ECB anticipates GDP contracting by 0.4% for this year as a whole, and expects only modest growth of 1% in 2014. Indeed, in last week’s press conference, Mr Draghi, remained cautious oneconomic recovery. He described it as “weak, fragile and uneven”, but he also noted the outlook is developing broadly in line with ECB expectations.
In summary, the ECB is keen to stress it has an array of instruments at its disposal. It remains cognisant to and willing to act on developments in relation to liquidity and short-term market interest rates in the eurozone.
However, there are no indications that any new policy initiatives are imminent, with the improving economic outlook reducing the likelihood of a further rate cut from the ECB. Therefore, it seems ECB rates are very much on hold.
John Fahey is a senior economist with AIB