In July, the ECB left interest rates unchanged, but no-one could call it a dull meeting. On the contrary, the ECB introduced its version of forward guidance, promising to keep rates at “present or lower” levels for an extended period of time. This seems to represent a major change in the ECB approach and amounted to a verbal easing of policy. To be sure the markets fully understood its message, ECB president Mario Draghi added that the possibility of further rate cuts, including of a negative deposit rate, remained open.
For Thursday’s meeting, we expect no further important decisions, nor surprising remarks by Mario Draghi, even if he will keep a dovish posture. Following activism in the past months, every central bank should aim for a pause, giving it time to sit back and see what effect its past decisions had. The ECB’s August meeting is a perfect occasion to keep a low profile, as central banks detest creating volatility, which is more likely in thin holiday markets.In addition, the recent economic data flow suggests that the expected economic recovery in the second half of the year is materializing, while also the
ECB bank lending survey contains some modest encouragement that the financial sector is healing. So, the ECB is under no pressure to act.
Nevertheless, the ECB governors will have to discuss a lot, as the next few months may be more difficult for the ECB. First and foremost, the Fed may decide to start tapering its bond buying programme. This could cause a lot of volatility, as was the case when the FOMC first suggested such an eventuality after its June meeting. EMU yields followed their US peers higher, even if the yield spread widened. With the EMU economy in recession for six quarters and unemployment at record highs, a US-induced rise in euro yields risks suffocating the embryonic recovery. Together with austerity fatigue and fast eroding political stability in the peripheral counties, this could rapidly develop into an explosive situation. This was probably the reason why the ECB introduced the forward guidance in the first place,
despite already some slightly improving eco data. The ECB might have to act more forcefully in the next months to sever the link between US and EMU rates and yields. Therefore, Mario Draghi is likely to keep his options open and not backtrack on last months’ dovish comments. Admittedly, Mario Draghi already a few times this year flip-flopped from dovish to less dovish, often without much changes in the underlying economic picture, but we don’t expect any marked change in tone this month.