- Mr Trichet hints at significant change in ECB thinking.
- Threat of further rate increases now removed.
- ECB rate cut now possible.
- Upcoming economic and market developments hold the key as ECB builds room for manoeuvre.
- New ECB projections downgrade near term growth outlook sharply while inflation risks are no longer seen to upside.
- ECB still urging budget austerity – might the trade off be an easing in monetary policy?
- Markets may speculate about co-ordinated international easing in coming months…
Today’s decision by the European Central Bank to leave its key interest rates unchanged was almost universally expected. What did come as a surprise was the extent of the change in the tone of ECB President, Jean Claude Trichet’s comments on the outlook for economic activity and inflation. While it is obvious that there has been a marked deterioration in economic prospects and financial market conditions of late, traditionally the ECB has been slow to respond to such developments and to alter its policy assessment unless confronted by seismic risks. Mr Trichet’s comments today hinted at a realisation that the current environment is one in which risks of that nature have begun to emerge.
The ECB’s recognition of sharply changed circumstances is evident (1) in its reassessment of the balance of risks both in relation to inflation and growth, (2) in a substantial downgrading of the near term outlook for economic growth in new ECB economic projections and, most notably, (3) in the tone of Mr Trichet’s comments today. These comments clearly suggested no further increase in interest rates is envisaged in the policyrelevant future and opened up some possibility that policy rates could be reduced.
Given that the ECB’s mandate is to deliver price stability, a key development today was a shift in its assessment from one in which it saw upside risks to price stability to one in which the outlook is seen as balanced. Last month’s reference to upside risks from ‘stronger than expected domestic price pressures in the Euro area’ no longer feature. Instead, the main downside risks to the inflation outlook comes from ‘the impact of weaker than expected growth in the Euro area and globally’. At a technical level, this change merely recognises the deterioration in the economic climate of late, however, in current circumstances, it amounts to a signal that the threat of further rate hikes has been removed.
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