ECB: In The Mood For Rate Cuts
BNP Paribas | Apr 05, 2013 07:24AM ET
At its April meeting, the ECB’s Governing Council decided to leave key policy rates unchanged. However, the door was clearly opened for further policy actions.
These actions could be taken as soon as next month. Economic conditions already plead for a rate cut. Inflation expectations are the main factor justifying a change in the refi rate. In March, inflation decreased to 1.7%, from 1.8% in February and 2% in January. Inflation should continue to ease going forwards. According to the ECB’s most recent macroeconomic projections (released in March), inflation is expected to average 1.3% next year, which is far below the central bank’s target for medium-term price stability. Several factors are bringing down inflation. First, it will decline for technical reasons. Several countries adopted fiscal consolidation measures in 2012, including raising VAT rates and administered prices, and once these measures disappear from year-on-year comparisons, inflation will automatically decrease. The sluggish economy is also weighing on price formation. The economic environment has deteriorated recently with survey data heading south. The unemployment rate has reached new highs and will continue to rise. Under these conditions, wage growth should remain moderate, reducing pressures on domestic inflation. President Draghi acknowledged that economic weakness is affecting core countries as well. This could jeopardise the ECB’s growth outlook, which is based on a gradual recovery in the second part of the year. Against this backdrop, Mr. Draghi said, “in the coming weeks, the ECB will monitor all incoming information on economic and monetary developments very closely” to assess their impact on the outlook for price stability.
Why hasn’t the ECB already cut interest rates? It probably wanted more time to evaluate the impact of recent events on the economy, and probably wanted to prepare markets for a change in interest rates. There is already evidence that conditions are deteriorating, with no signs of improvement in the months ahead, making an interest rate cut even more likely. Events in Cyprus and Italy have tightened financial market conditions a little. Renewed tensions have increased bond market yields, while equity indices have fallen. Banking sector CDS have been rising, mainly in the peripheral countries, deteriorating bank funding conditions. The latest ECB bank lending survey was rather disappointing, with banks expecting credit conditions to tighten a little over the quarter. It is not surprising that credit in the eurozone is still contracting, with lending to non-financial corporations falling by 2.6% y/y in January 2013, close to the historical low of -2.7% y/y reported 3 years ago.
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