In August, consumer price inflation remained unchanged at 0.2 % (y/y, flash estimate). The CPI outcome was in line with our estimate that is based on average historical month-over-month changes in consumer prices. The tracking model implies average 2016 inflation of 0.2 %; broadly in line with current Bloomberg consensus expectations (0.3 %). The core inflation rate inched surprisingly lower in August (from 0.9 % y/y to 0.8 %), while an unchanged outcome was expected by Bloomberg forecasters.
At Thursday’s meeting, the European Central Bank (ECB) left its monetary policy stance unchanged. The governing council decided that the main refinancing rate and the interest rate on the deposit facility remain unchanged at 0.0 % and minus 0.4 %. The governing council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. In addition, the ECB confirmed that the monthly asset purchases of 80 bn EUR are intended to run until the end of March 2017, or beyond, if necessary, and in any case until it sees a sustained adjustment in the path of inflation consistent with its inflation target (2 %). The outcome of the governing council meeting was as expected by a majority of financial market participants. Some investors already expected an extension of the asset purchase programmes by six months from March to September 2017, while most analysts seem to anticipate a further expansion of monetary policy until year end.
There were minor revisions in the ECB’s quarterly staff macroeconomic projections. The ECB forecasts annual Euro Area GDP growth of 1.7 % in 2016 and of 1.6 % in 2017 and 2018. Previously (in June), the ECB staff had forecast annual GDP to grow by 1.6 % in 2016 and by 1.7 % in 2017/18. This implies that the ECB did not take into account a significant growth slowdown amid negative (sentiment and financial) spill-over effects from the British Brexit-vote. In the introductory statement to yesterday’s press conference following the governing council meeting, President Draghi noted that “…the available evidence so far suggests resilience of the euro area economy to the continuing global economic and political uncertainty…” However, he added that the baseline scenario remains subject to downside risks. The ECB expects annual inflation of 0.2 % in 2016, 1.2 % in 2017 and 1.6 % in 2018. The inflation forecast is mostly unchanged compared to the June projections (-0.1 percentage points in 2017).
What does yesterday’s ECB meeting imply for the interest rates outlook?
The ECB’s forward-looking phrase to expect the key policy rates “to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases…” pins down the entire Euro Area yield term-structure around the current historically low levels at least until March 2017. In case the asset purchase programme is not extended beyond March 2017, the ECB would likely announce a slowdown of the monthly asset purchases (‘tapering’) around that time. For comparison, the US Fed had started tapering in December 2013 and it took almost one year to slow down monthly asset purchases from 85 bn USD to zero (in eight reductions of each 10 to 15 bn USD). Assuming a comparable tapering speed and assuming that the ECB would first run down asset purchases before embarking on a rate hiking cycle (as implied by the above quote), the ECB would not start increasing the key policy rates before Q1 2018 (bearing in mind that by that time, the inflation rate – according to the ECB’s own forecast – would still be well below the inflation target). What would be the speed of the rate hiking cycle? Assuming that the ECB would proceed as cautious as the Fed, then it would likely increase the key rate by one or two steps of each 25 basis points per year. Hence, it would take at least until 2022 to take the ECB main refinancing rate to 2.5 %.