Overview
Against a slowing global economic backdrop, the ECB’s measures are entirely justified. And by delivering much more than expected at today’s meeting, the central bank has essentially removed any need for big policy decisions at least until year-end and possibly beyond.
Dovish surprise
As expected, the ECB kept its policy rates unchanged at today’s meeting. The announcement of the third Targeted Long-Term Refinancing Operation (TLTRO III) was also widely expected, but the details provided in the statement were not anticipated by markets before the next meeting.
The biggest dovish surprise for markets was the change to forward guidance, which now states interest rates will remain at present levels “at least through the end of 2019”, as opposed to the previous guidance “at least through the summer”.
The Governing Council has judged that the trajectory of the economy since the last meeting has been below their expectations, justifying a further dovish shift and delaying policy normalisation plans beyond ECB President Mario Draghi’s term.
The ECB’s more bearish view on growth and inflation was reflected in downgrades to their forecasts which were much larger than expected. Draghi emphasised that the ongoing slowdown in growth is likely to persist through the year, mostly because of external factors such as political uncertainties and weakness in demand from outside the Eurozone. At the same time, muted inflation also drove today’s policy adjustment.
Global headwinds
The ECB’s measures are entirely justified by the macro backdrop - the slowdown in global activity continues and there is little evidence to date of any ‘green shoots’. Weakening growth in China, tighter global conditions globally, trade-related uncertainty and some country-specific factors all combined to exert a drag on Eurozone economies over the past year. Those economies which are most closely linked to these factors have been carrying the burden of adjustment, with Germany a clear example.
At this juncture, it is hard to argue that any of these headwinds are reversing in a meaningful way. China activity shows no signs of bottoming out for now and it is still highly uncertain if the amount of stimulus already announced is enough to engineer any rebound in the short term.
Despite some easing in global financial conditions since the start of the year, a related drag on growth will remain in the system for the next few quarters at least, and any sharp unwinding of that tightening is not our base case scenario. Geopolitical uncertainty is likely to continue to dominate investor sentiment, with Europe possibly becoming the next target of US-led trade protectionism.
In all, by delivering much more than expected at today’s meeting, the ECB has essentially removed the need for big policy decisions at least until the end of the year and possibly beyond. In the absence of any big shocks through 2019, the ECB stance should remain unchanged for the time being.
