ECB hints at taking further monetary policy action in September

188/8/2016

By Claire Jones in Frankfurt

The European Central Bank has hinted at taking further action next month should economic conditions in the eurozone fail to improve, with its top policymakers saying the impact of the latest wave of uncertainty to hit the global economy needed “very close monitoring”.

The latest edition of the central bank’s monetary policy deliberations — for the meeting on July 21 when it decided to keep rates on hold — indicated the governing council may well act according to analysts’ expectations and keep its ultra-loose monetary policy in place for longer when it next meets on September 8.

Europe’s recovery has remained on track, but aftershocks from the UK vote to leave the EU and the poor health of the region’s banks risked its derailment. The so-called Brexit vote was expected to affect primarily the UK economy, but the unpredictability of the impact on trade meant the UK’s decision to break ties with the EU “could affect the global economy in deeper and less predictable ways than through the direct trade channel”, the minutes said.

“In the current environment of heightened uncertainty, a still high level of economic slack and weak wage and price pressures, future discussions were called for regarding wage trends, inflation expectations, the medium term orientation of monetary policy and the time horizon over which the very accommodative monetary policy stance would remain warranted.”

The tone of the remarks will raise hopes of an extension of the central bank’s €80bn-a-month quantitative easing programme beyond the current spring of 2017 deadline.

Some central bank watchers think the ECB will also ease the rules governing which bonds can be bought under the flagship QE programme. The minutes offered little clue as to how the rules could be relaxed, saying only that the lack of evidence on how the latest headwinds would affect the eurozone meant “it was widely felt among members that it was premature to discuss any possible monetary policy reaction at this stage”.

Research published by S&P, a rating agency, on Thursday suggested the UK leaving the EU could limit the effectiveness of the ECB’s negative interest rate policy, by lowering the value of the pound against the euro — though policymakers are more concerned about the exchange rate to the dollar.

Financial markets has weathered much of the turmoil that followed the UK’s Leave vote, but share prices for financial companies were still volatile and remained below their pre-referendum levels. This reflected concerns over banks’ low profitability in an environment of low rates and weak growth, as well as high volumes of bad loans.

The ECB minutes added that policymakers referred to the link between banks’ share prices and lending volumes. The possibility of a slowdown in lending would concern policymakers, who are keen for the impact of their actions to be fed to the broader economy through a wave of credit creation by banks.

Inflation has risen in recent months, but the ECB’s chief economist Peter Praet said “underlying price pressures continued to lack a convincing upward trend and remained an ongoing source of concern”.

The ECB kept interest rates on hold at the July vote. The main refinancing rate and the deposit rate remain at record lows of zero and minus 0.4 per cent.

In September, ECB’s staff will publish a fresh set of forecasts for the eurozone. In their June projections, economists at the central bank said growth would reach 1.6 per cent this year, and 1.7 per cent in both 2017 and 2018. Inflation would be just 0.2 per cent this year, but would rise to 1.3 per cent in 2017 and hit 1.6 per cent the following year.

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