Last week’s ECB monetary policy meeting saw no changes being made, despite some expectations in the market of a rate cut or some new liquidity measures.
Nonetheless, the ECB emphasised that it is firmly committed to maintaining an accommodative monetary policy stance for as long as is necessary.
The ECB retains a clear easing bias, given its forward guidance that rates will remain at present or lower levels for an extended period of time. ECB president Mario Draghi indicated that the governing council needs more information in regard to the problems in emerging markets, credit flows, the real economy and inflation, before making any decision to ease policy further.
He listed two circumstances where the ECB would consider further policy easing. The first is in relation to an unwarranted tightening of short-term money rates. The second would be a worsening of the medium-term economic outlook, in particular a further fall in inflation from its already very low level.
Mr Draghi gave no indication which policy tools the governing council might opt for, if it does indeed decide that further measures are needed to help the economy. There is scope for a further small cut in the refi rate, which is currently set at 0.25%. Alternatively, it could take measures to inject more liquidity into the system to lower market interest rates.
In terms of the economy, activity surveys suggest that the recovery picked up pace in the final quarter of 2013 and in the opening month of this year. The eurozone’s composite PMI, a good leading activity indicator, averaged 51.9 in the fourth quarter of 2013, compared to 51.4 in quarter three.
There was a solid rise in this index over the past two months in particular, as it climbed from 51.7 in November to 52.1 in December and 52.9 in January. The German PMIs have been particularly strong, with its composite PMI averaging over 55 in the latest three months.
Another important leading indicator of activity, the EC’s economic sentiment survey, has also picked up strongly in recent months, reaching a 30-month high of 100.9 in January. Meanwhile, the key German Ifo also hit a 30-month high of 110.6 in January, while the French INSEE business sentiment index reached a 27-month high of 100.
All these leading indicators are now well above the levels that pertained in the first half of last year. The latest data suggest that the recovery in activity has gained momentum since last autumn. GDP is likely to have risen by 0.2%-0.3% in the fourth quarter, up from 0.1% in quarter three.
The GDP report for the final quarter of last year will be released on Friday, which combined with the various activity surveys for February, will give the ECB a good picture of the economy at its March policy meeting.
The ECB will also be paying close attention to the inflation figures for February. The annual inflation rate fell to 0.7% in January, raising concerns about the risk of deflation in the eurozone. A further fall in inflation could prompt the ECB to ease policy further.
Meanwhile, the data on monetary aggregates were very weak at the end of last year. The ECB suspects that this may be partially due to banks readying their balance sheets for the stress tests being done this year.
The tests will be based on banks’ balance sheet positions at end 2013. The ECB will be watching the monetary data for early 2014 to see if some of the weakness evident at the end of last year unwinds.
Finally, if the difficulties in emerging markets develop, it could knock the eurozone’s recovery off course and put further downward pressure on inflation. Thus, the ECB has many things to consider as it deliberates over monetary policy.
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