Today’s April meeting of the ECB’s Governing Council resulted in the expected no policy change outcome. In terms of the ECB’s view of the macroeconomic conditions, it is clear from today’s update that the Council has become more pessimistic and less confident in its recovery scenario and as a result the ECB has clearly become more dovish.
There were a number of significant changes in the statement that reflect this more downbeat assessment of the macro picture. The ECB recognise that the economic weakness has “extended into the early part of the year”. There is no longer a reference in the statement to an expected “stabilisation” in activity levels in the first half of this year. On the back of this, the Governing Council have given greater emphasis to the “downside risks” facing the macro outlook, referencing these risks in the opening paragraph this month. The more pessimistic view on the economy was also illustrated in the Q&A section of the press conference, where President Draghi acknowledged that the economic weakness has now extended to countries which do not presently suffer from fragmentation (i.e. market stress).
Given this more downbeat macro assessment it is not surprising then, that today’s statement and press conference included more dovish language from a policy perspective. The comment President Draghi made at the March press conference in relation to monetary policy remaining accommodative “for as long as is needed” is now explicitly referenced in the opening paragraph of today’s statement. The Governing Council now also state that they will “in the coming weeks, monitor very closely” the incoming economic data, in terms of what it is saying about the economy’s performance and the potential impact on its key objective of price stability. Recent declines in inflation – it has fallen to 1.7% in March from 2.7% last September – were also given explicit mention by Draghi in the Q&A session. President Draghi summarised the current ECB view by stating that he and his colleagues ‘stand ready to act’, which means they will loosen monetary policy if they deem that economic conditions warrant such a move.
In terms of this month’s policy discussion, the ECB President informed us that there was an extensive discussion on interest rate policy, with the “consensus” for the time being not to change rates. In other words, there were some members of the ECB calling for a rate cut this month, as was the case at last month’s ECB meeting.
Beyond interest rate policy, Draghi also indicated that the ECB is currently studying the potential for additional non-standard measures to contribute to an improvement in the transmission of its policy stance. In particular, Draghi explained that the ECB is actively looking at possible instruments and tools which could help improve the flow of credit to the real economy, particularly for SMEs. He did not provide any detail on the nature of any such supports beyond saying that the experience of other economies is being examined with a view to considering what might be useful, feasible and effective in a euro zone context. He indicated that any such programmes, to have ECB involvement, would need to be consistent with the ECB’s price stability mandate, though he added that there was a strong case for other institutions including governments, the European Investment Bank, and national central banks to also be involved in their design and implementation.
Unsurprisingly, Draghi also faced a considerable level of questioning on recent developments in Cyprus. He said the ECB had presented a proposal that did not include any bail-in of insured depositors. However, the negotiations which followed moved away from that principle, culminating in the initial, botched package which incorporated haircuts for all depositors – which Draghi described as “not smart to say the least”. Clearly opposed to the idea of imposing losses on insured depositors, Draghi noted that this mis-step was quickly “corrected” the following day.
He defended the ECB’s stance on the provision of exceptional liquidity assistance (ELA) to the banks in Cyrpus, arguing that the ECB would have been operating politically and beyond its remit had it not objected to the idea of providing ELA to insolvent and non-viable banks (which the banks in Cyprus would have been in the absence of the bailout).
Finally on Cyprus, he went out of his way to make clear that Cyprus is not to be viewed as a template for other countries potentially requiring future support. He went on to point out that bail-ins of suitable creditors in the appropriate order are not necessarily problematic, but that one of the reasons why it is problematic in Europe (including in relation to the Cypriot experience) is that, at present, there is no agreed framework governing how they operate. The absence of rules which are “known to all” relevant parties makes potentially-damaging “ad-hocery unavoidable” in Draghi’s view. In this context, Draghi noted that one of the key lessons from the experience with Cyprus was the need for governments to fast track implementation of the banking union and called for implementation of Commission proposals governing a new bank recovery and resolution framework to be brought forward to 2015 or earlier from the planned 2018 date.
Overall, today’s update from Draghi reveals an ECB that is clearly moving in the direction of more action to support the euro area economy. An interest rate reduction as early as next month is now a live possibility, depending as ever on how the incoming economic news plays out in the weeks ahead. We think timely surveys such as the April PMIs and those from the European Commission will be among the key indicators to watch in this respect. Moreover, it looks as if the Draghi ECB is also prepared to dip its toes further into “non-standard” waters to help improve the flow of credit to the real economy, albeit that new initiatives on this front look perhaps less imminent. Watch this space…