Cheap money to remain ECB stimulus policy

As expected, the ECB left its interest rate policy unchanged at the December meeting of the Governing Council last Thursday. The main refi rate remains at 0.25%, while the deposit rate was left unchanged at 0%.

Having surprised markets with a 25bps cut in the refi rate at its November meeting, the expectation was that there would be no fresh moves this month.

However, the ECB left the door open for further policy easing if required. ECB president Mario Draghi once again reaffirmed its forward guidance on interest rates. He said the ECB expects its key interest rates to “remain at present or lower levels for an extended period of time”.

Mr Draghi noted that the forward guidance has been successful in persuading markets that rates would remain low for a prolonged period. With the deposit rate already at 0%, Mr Draghi again confirmed the ECB is technically ready for a move to negative rates if required. Thus, even with interest rates already at extremely low levels, the ECB retains a clear easing bias.

Further policy easing, though, is not confined to cutting rates. There has been speculation that the ECB may launch a fresh, long-term refinancing operation, or announce new measures to try to boost bank lending. However, a further rate cut would seem the preferred option, if more action is needed.

The reasons for the easing bias are clear from the latest set of ECB staff quarterly economic forecasts, published in conjunction with the council meeting. These also contained the ECB’s first forecasts for 2015.

The November rate cut was primarily driven by the fall in inflation to below 1%. The ECB believes the eurozone now faces a protracted time of very low inflation.

In its latest forecasts, the ECB sees the HICP inflation rate averaging 1.1% in 2014 and 1.3% in 2015, well below the 2% target level. Meanwhile, it would seem that stronger global growth, some improvement in private sector demand on the back of very low inflation, the accommodative stance of monetary policy, and improving confidence have all helped spur a modest pick-up in eurozone activity.

After emerging from recession in the second quarter, the eurozone economy continued to grow in the third quarter, albeit slowly. GDP increased by just 0.1%, compared to 0.3% in the previous quarter. Recent leading indicators of economic activity suggest that the recovery has continued in the fourth quarter.

The eurozone’s composite PMI, a good leading activity indicator, averaged 51.8 in October/November, which is slightly better than the third quarter average of 51.4. Another important leading indicator of activity, the ECB’s economic sentiment index, has picked up strongly in recent months, reaching a 27-month high of 98.5 in November.

Meanwhile, the key German Ifo and French INSEE business sentiment indices rose to a 19-month high of 109.3 and a 26-month high of 98.1 in November, respectively. Overall, various leading activity indicators suggest the economy picked up pace in the past couple of months, but growth still remains moderate.

The latest ECB forecasts point to a continued modest recovery in activity. GDP growth of 1.1% is forecast for 2014, with a rise of 1.5% predicted for 2015. This moderate growth, though, will not make much inroads into high unemployment, with eurozone joblessness rising above 12% this year.

Overall, the ECB forecasts indicate that a very accommodative monetary policy will be required for at least the next couple of years.

Hence, the current loose monetary policy can be expected to remain in place. Indeed, further policy easing could be on the cards next year if the ECB projections on inflation and growth look like being significantly undershot.

* Oliver Mangan, chief economist, AIB

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