The fact that the European Central Bank didn’t change its key interest rates or announce any new policy initiatives today came as little surprise to financial markets. Neither were there any dramatic changes in the tone of comments made by ECB President Mario Draghi at the monthly press conference that followed today’s Council meeting of the ECB Governing Council. A fractional rise in money market interest rates and in the FX value of the Euro suggests some had expected a clear softening of the ECB’s stance to be signalled. Instead, there were subtle signs that recent weakness in survey data and signs of a continuing deterioration in the jobs market are having some impact on ECB thinking. These poorer numbers prompted Mr Draghi to emphasise the ‘prevailing uncertainty’ in the current environment. At very least, we remain some considerable distance from any tightening of ECB policy but a more intriguing issue raised by today’s comments is what scale of deterioration in economic conditions might be required to prompt the ECB to consider easing policy further.
In our commentaries on the monthly ECB policy meetings for March and April we suggested there had been a slight hardening of ECB thinking that reflected (1) some increased nervousness about inflation (2) a greater confidence that the Euro area economy was recovering (3) a sense that the ECB had made a dramatic and decisive intervention through its two tranches of three year LTRO’s and (4) an instinctive discomfort with the current accommodative policy setting on the part of a number of the more hawkish members of the Governing Council.
Subtle recognition downside risks
A number of subtle changes to today’s ECB press statement suggests the ECB recognises increased risks to the downside for Euro area activity and that those of a more dovish disposition have gained a greater measure of influence. The first paragraph reflects the significant weakness seen in a number of survey indicators for April by highlighting the ‘prevailing uncertainty’ in the current environment although the statement goes on to say that ‘economic activity is expected to recover gradually over the course of the year’. In response to a question, Mr Draghi noted that recent indicators weren’t enough to change the ECB’s expectations for a gradual recovery but he added that the outlook would probably be clearer next month when new ECB forecasts are presented.
Impact fiscal adjustment on eco growth
We feel that ECB thinking may also be influenced by revised expectations of the negative impact of austerity measures on economic growth. In an unusual discussion of fiscal consolidation towards the end of today’s press statement, the ECB acknowledged that ‘the necessary fiscal adjustment is weighing on near term economic growth.’ The press statement goes on to suggest that this adjustment will mean that ‘in an environment of enhanced confidence in fiscal balances, private sector activity should also be fostered, supporting private investment and medium term growth’. This means that the payback for adjustment in terms of a recovery in activity may not materialise for some time. Although these comments don’t provide any particularly new insight, their inclusion in the ECB press statement represents something of a departure and seems to reflect a greater appreciation of the immediate consequences of significant budgetary adjustments given the fragility of current conditions.
What we would regard as a relatively modest step-up in ECB concerns about the prospects for activity in the near term was accompanied by a fairly limited toning-down of concerns about inflation. Last month’s press statement had highlighted ‘upside risks in the near term’ – a worry which no longer features in today’s comment. This change is unlikely to stem from the marginal drop in inflation to 2.6% reported for April from the 2.7% rate that had prevailed for the previous four months. However, recent survey data point to some easing in price pressures that could be expected to be amplified further by a softer trajectory in activity. At a general level, it would seem that inflation concerns are no longer quite as prominent because of the emergence of potentially more threatening uncertainty about the health of the Eurozone economy. Conspiracy theorists would probably add that a significant and timely toning down of inflation concerns would also be a necessary precondition for any potential discussion of a further policy easing in the months ahead.