Carsten Brzeski's blog

ECB meeting: High-class problems and patience

ECB keeps rates on hold and sticks to its dovish bias.

As expected, the ECB kept all interest rates on hold at today’s meeting. At the same time, the ECB continues its dovish bias, pointing to a possible stepping up of QE if need be. Increased German unease about rising inflation rates was elegantly tackled by ECB president Draghi during the Q&A session.

It did not come as a surprise that only six weeks after the ECB’s December decision to extend QE at a lower pace until at least the end of 2017 the ECB was not up for any new measures today. According to Draghi, the ECB has not even discussed the details of how it will reduce the monthly purchases from currently 80bn euro to 60bn euro, starting from April. As regards the economic outlook for the Eurozone, the ECB still sees a continuation of the gradual recovery, confirmed by strong sentiment indicators. According to Draghi, risks to the outlook were still tilted to the downside, mainly stemming from external factors.

The more interesting topic was the ECB’s assessment of inflation developments. Here, the latest increase in headline inflation had led to some speculation among market participants about a possible ECB reaction. Obviously, Draghi downplayed the latest increase in headline inflation, as – according to him - the increase was mainly a result of higher energy prices. He did not see any signs yet of convincing upward trend in underlying inflation. In our view, the ECB does not consider energy-driven increases in headline inflation a “sustained adjustment in the path of inflation”.

Low underlying inflation combined with the sluggish recovery and external uncertainties are the reasons for the ECB’s continued dovish bias. In this context, the key sentence today (and probably in the future) was “if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the programme in terms of size and/or duration.” Only once this sentence has been dropped, the ECB will be ready for tapering. Also, the ECB had not discussed what it would do if growth and/or inflation would overshoot in the coming months. Draghi called an earlier reduction of QE a high-class problem.

The latest increase in headline inflation had led to renewed criticism of and opposition against the ECB’s current monetary policy in Germany. This morning, two of Germany’s most popular news sources stirred the debate again. Looking somewhat tired by regular German opposition, Draghi defended the ECB’s current monetary policy stance once again, calling for patience and also laid out four criteria for a sustained adjustment in the path of inflation: i) a durable convergence of inflation to below but close to 2%; ii) the increase should not be transitory; iii) inflation should be self-sustained; and iv) the inflation improvement had to be across the entire Eurozone. Particularly the latter could actually even give the ECB the option for future extensions of QE. Let’s not forget that as long as peripheral countries have to restore growth by structural reforms, a pick-up in inflation is unlikely. It is almost ironic but if Germany wants higher interest rates and an end to QE, it would have to allow for fiscal stimulus in the periphery.

All of this means that the ECB is far away from any tapering. It will need a significant increase in core inflation and wages before the ECB would consider a further, faster or earlier reduction of QE. For the time being, the ECB will stay on its autopilot. In our view, even a hint at 2018 tapering will not come before the summer, after the Dutch and French elections and the first possible impact of new US economic policies. Draghi will only have to calm critics with soothing words from the cockpit once in a while.