There was little expectation that the European Central Bank would cut interest rates at yesterday’s policy meeting. So, there was no surprise when the announcement came that they were left unchanged. However, this decision may have been a little bit closer than generally thought. New ECB projections show a notably poorer outlook for activity and a lower inflation rate than previously envisaged. In addition, Mr Draghi acknowledged that a rate cut had been discussed as had the more contentious issue of a negative
The general tone of Mr Draghi’s comments suggest the ECB is more open to the possibility of a further cut in its key policy rates than many in the market had anticipated.
However, as we noted in previous assessments, clearer signs of a further weakening in Euro
area conditions, entailing a softer trajectory for ‘core’ economies, may be needed to forge a consensus for a further easing.
Economic Outlook Downgraded
Today’s new ECB staff projections show a notable reduction in the outlook for growth through 2013. The midpoint of the new staff projection envisages a fall in GDP of 0.3% next year, a significantly weaker outcome than +0.5% increase in GDP seen in the ECB’s September projection.
This represents a relatively large amendment to what was already expected to be as a sluggish Eurozone economy in the year ahead. Arguably of greater significance, the ECB’s new forecast is notably lower than recent forecasts by the EU Commission (+0.1%) or OECD (-0.1%).
Today the ECB also published its first estimate for Eurozone growth in 2014. This envisages some recovery in GDP growth (the midpoint of the projection is +1.2%). However, the details of today’s projections suggest an extended period of subpar economic activity—and today’s ECB statement also acknowledged that risks to the outlook remain to the downside. Consumer spending is now expected to decline by 0.6% in 2013 (compared to a flat outturn expected in September) and is only seen recovering by 0.5% in 2014. So, consumer spending across the
Eurozone will remain fairly depressed for the next couple of years.
In these circumstances, the outlook for employment and unemployment (the ECB does not publish projections for these variables) must be something of a concern at the policy making level across Europe. As diagram 1 below shows, the Euro
area unemployment rate has been on a very sharp upward trajectory for the past eighteen months.
With budget austerity limiting the scope for responses from other macro policies, there is some risk that the ECB may be required to take further action to support a deteriorating Eurozone economy in the first quarter of the next year.
Today’s new ECB projections also suggest significantly less concern about the inflation outlook in Wilhelm-Epstein- Straße of late. In part, this reflects the significant easing in the flash estimate of November inflation reported last week. As diagram 1 above indicates, this has returned the current inflation rate to its lowest level in two years and very close to the ECB’s target range. Together with the weaker outlook for activity, this has prompted a downgrading of the ECB’s inflation projection for 2013 from 1.9% to 1.6% and a further easing in inflation to 1.4% is seen in 2014. It should be noted that Mr Draghi emphasised that the inflation outlook remains in line with the ECB’s target and that the Governing Council’s views had not changed substantially. However, new projections and the general tone of Mr Draghi’s comments on the economic outlook today suggest inflation is unlikely to present any significant obstacle to an easing in ECB policy if this is deemed necessary in early 2013.