Eurozone
• ECB extending asset purchases
• ‘Tapering’ not on the table
• ECB inflation forecast below target until 2019
In the meeting of the governing council (GC) that took place last Thursday, the ECB decided to leave the main refinancing rate, the marginal lending rate and the deposit rate unchanged at 0.0 %, 0.25 % and -0.4 %. The GC continues to expect the key 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 (‘quantitative easing’, QE).
Regarding the non-standard monetary policy measures (QE), the GC decided to continue its purchases under the asset purchase programme (APP) at the current monthly pace of 80 bn EUR until end of March 2017. From April 2017, the net asset purchases are intended to continue at a reduced monthly pace of 60 bn EUR until the end of December 2017, or beyond, until the ECB sees a sustained adjustment in the path of inflation consistent with its inflation aim. If the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the GC would increase the programme in terms of size and/or duration. The net purchases will be made alongside reinvestments of the principal payments from maturing securities under the APP.
In addition, the GC decided to adjust the terms of the APP as of January 2017. The maturity range of public sector bond purchases will be broadened by decreasing the minimum remaining maturity for eligible bonds from two years to one year. Furthermore, purchases of securities with a yield to maturity below the ECB’s deposit rate (-0.4 %) will be permitted to the extend necessary.
The updated ECB staff macroeconomic projections for the Euro Area foresee annual real GDP increasing by 1.7 % in 2016 and 2017, and 1.6 % in 2018 and 2019. Although the ECB stated that risks of the growth outlook remain tilted to the downside, the forecast does not imply a slowdown that could still be induced by negative spill-over effects from UK following the Brexit referendum in June. Also, President Draghi sees the economic expansion “to proceed at a moderate but firming pace”. With regards to inflation, there are no signs yet of a convincing upward trend in underlying inflation. HICP inflation is expected to pick-up to 1.3 % in 2017, 1.5 % in 2018 and 1.7 % in 2019. The December projections extended the forecast horizon until 2019 (while, previously, in September the forecast ranged until 2018). This reveals that the central bank does not expect inflation to rise towards its 2 % inflation target or, at least, not until the second half of the 2019. Hence, it also points towards a prolonged period of near-zero key policy rates and even and expansion of the asset purchase programme beyond end-2017, as indicated in President Draghi’s statement. Draghi also indicated during the Q&A session, that the 1.7 % inflation projection for 2019 is “not really” in line with the goal of “below but close to 2 %” inflation target of the ECB; a “dovish” remark. The prolonged period of low underlying inflation also implies a very slow closure of the Eurozone’s negative output gap (a theoretical measure of underutilization of economic resources and labor) and a prolongation of the low-interest rate environment.
It is consistent with our own expectation of a prolong period of a low though gradually rising real and nominal interest rate environment. Referring to a meta-analysis that Williams (2014) conducted on econometric estimates (of mostly peer-reviewed journal articles) of effects of large-scale asset purchases, we have been highlighting that central bank asset purchases of around 900 bn EUR (1.000 bn USD) have an estimated negative impacted of on average 40 basis points on the yield level.
With respect to the effects on growth and inflation, President Draghi said that past decisions accounted for a cumulative 1.3 percentage points GDP growth and 1.5 percentage points of inflation over a three year horizon. Given that past decisions invoked asset purchases summing up to 1.800 bn EUR, a back-of-an-envelope calculation would suggest that additional purchases (60 bn EUR x 9 months = 540 bn EUR) lead to a rise of around 0.4 percentage points in GDP and 0.5 percentage points in inflation. Weale and Wieladek (2016) estimated even larger effects. According to their estimates for the US and UK, asset purchases amounting to 1 % of nominal GDP would induce a rise of 0.58 % (US) and 0.25 % (UK) in real GDP and 0.62 % (US) and 0.32 % (UK) in inflation.
During the Q&A session, President Draghi mentioned that ‘tapering’ has not been discussed in the GC meeting. In a narrow sense, tapering refers to the step-wise shut-down or incremental cutbacks of the monthly asset purchases with the aim to close the asset purchase programme (Draghi: “policy whereby purchases would gradually go to zero”). It was not on the table in the GC meeting, according to President Draghi.
USA
• Fed expected to hike key rate
At the December meeting of the federal open market committee (FOMC) taking place on 13th-14th December, the Fed is expected to increase the target range of the federal funds rate by 25 basis points to 0.5 % to 0.75 %. For financial investors the rate hike is a done deal as the market implied probability is currently at 100 %. The Fed will also release updated quarterly macroeconomic projections on Wednesday following the FOMC meeting. Currently, the consensus real GDP growth expectation (among analysts reporting forecasts to Bloomberg) is 2.2 % for 2017 and 2.3 % for 2018. U.S. inflation is currently projected to increase to 2.3 % next year and 2.4 % in 2018. U.S. interest rates have been rising recently in anticipation of rising inflation, higher growth prospects and a December Fed funds rate hike
Williams, J. C. (2014): Monetary Policy at the Zero-Lower Bound, Putting Theory into Practice, Hutchings Center on Fiscal & Monetary Policy at Brookings
Weale, M. and Wieladek, T. (2016): What are the macroeconomic effects of asset purchases, Journal of Monetary Economics 79: 81-93