ECB Commits to Lift Inflation With Forecast Built on Market Viewby
Central bank publishes account of Sept. 7-8 policy meeting
Officials wanted to leave ‘no doubt’ QE can be completed
The European Central Bank said it will do what’s needed to meet its inflation goal, and acknowledged that the path to get there is partly built on investor expectations for future stimulus.
“The projected path of inflation was conditional on exceptionally supportive financing conditions, which to a large extent reflected the current accommodative monetary-policy stance and prevailing market expectations about the future course of monetary policy, according to an account of the Sept. 7-8 meeting published on Thursday. “Members reiterated their full commitment to bringing inflation back to levels in line with the Governing Council’s medium-term aim without undue delay.”
With less than six months to go until asset purchases are currently scheduled to end, the ECB is studying the future of its quantitative easing. President Mario Draghi, who has pledged to extend the program if needed, has ordered a review of self-prescribed rules governing the program to ensure the central bank won’t run out of bonds to buy, while an informal consensus has built among officials that purchases will be eventually be tapered rather than stopping suddenly.
In September, the ECB predicted price growth would accelerate to an average of 1.6 percent in 2018, remaining below its goal of just under 2 percent that the institution hasn’t met since early 2013. The rate stood at 0.4 percent in September.
“Underlying inflation was still not showing convincing signs of a sustained pick-up, which warranted continued close monitoring of price trends and of economic and financial market developments,” according to the accounts, which also say that the Governing Council expects headline and core inflation to converge in early 2017.
In the run-up to last month’s meeting, there was broad agreement among economists and investors that officials would extend QE. The asset-purchase program, originally designed to last until September, was prolonged by six months once already and is currently scheduled to end in March.
It is “of crucial importance to preserve the very substantial degree of monetary support that was embedded in the staff projections, while it was also cautioned that the Governing Council should not be unduly influenced by prevailing market expectations,” the accounts said. “Members widely agreed that policy action at the present meeting was not warranted and that the focus should remain on ensuring the full implementation of the policy measures so far decided.”
Reference was made to overly optimistic inflation forecasts published in the past, which was seen as downside risk to the baseline outlook, according to the account. Officials concluded that there were “good reasons” to believe those errors might not be repeated in the future, as the impact of labor-market reforms fades and some effects distorting wages diminish.
The ECB attributed the small downward revisions it made to its forecast for growth in 2017 and 2018 to external rather than domestic factors, which largely reflect weaker trade with the U.K. after it decided to leave the European Union. Officials concluded that it was “too early to say” whether expected adverse economic effects related to Brexit were overstated.
ECB Executive Board member Benoit Coeure noted in his review of financial-market developments at the start of the policy meeting that the institution’s asset-purchase programs are leaving an increasing “footprint” in financial markets that he attributed to a larger volume of purchases since April and less liquidity in the summer months.
“While the implementation of the APP was continuing to progress smoothly overall, the present constellation of interest rates was posing increasing challenges to implementation in the future,” the account quoted him as saying. “Borrowing rates for some government-bond collateral had deviated from ECB policy rates, highlighting increasing scarcity of some bonds.”
The Governing Council tasked the ECB’s committees in September to review its QE rules, amid concern that scarcity in some parts of the market means the central bank won’t be able to finish the current program, let alone extend it.
Analysts have proposed raising limits on individual bond purchases, deviating from the so-called capital key -- which would effectively allow more buying from highly indebted nations such as Italy -- or scrapping the minimum-yield requirement for securities. Draghi, who has said the program has enough flexibility to reach its goals, declined to elaborate on the options that could be deployed.
“The view was widely shared that reassurance had to be provided about the Eurosystem’s ability to ensure the smooth implementation of the APP,” policy makers concluded at their September meeting. “It was underlined that the Governing Council could adjust the parameters of the program at any time to achieve the intended amounts. There should be no doubt about the Governing Council’s determination to execute its asset purchases in line with its past decisions and to adopt further measures, if needed, to fulfill its price-stability objective.”
The International Monetary Fund raised its growth forecasts for the euro area on Oct. 4 and urged the ECB to maintain its “current appropriately accommodative stance.” At the same time, fiscal policy should be used to support the economic recovery by funding investment, the Washington-based lender argued.
The IMF holds its annual meeting in the U.S. capital this weekend. ECB policy makers are due to speak at events around those talks, with Draghi scheduled to address the press on Sunday.
At their September meeting, policy makers repeated their “strong call” for governments to flank loose monetary policy with “adequate fiscal policies and structural reforms” to make growth stronger and more sustainable.
After years of urging public-sector initiatives to bolster economic growth, the ECB stepped up its game in spring, when it set up a task force on economic reforms to consider the impact of various fiscal strategies. Draghi also used appearances in front of the European and German parliaments in the past two weeks to tell lawmakers that they need increase their efforts and shouldn’t waste opportunities created by ultra-expansionary monetary policy.
Policy makers have also rebuffed criticism recently that the ECB’s low-interest-rate policy is hurting financial institutions. Draghi told banks and insurers to stop blaming the actions of central banks for their problems and focus on fixing their business models and risk failings, and Executive Board member Yves Mersch said lenders that can’t withstand temporary strains on their earnings may have bigger questions to answer about their future viability.
Even so, the Governing Council pointed to some concern that structural challenges for banks pose a risk to monetary-policy transmission, saying developments in bank lending “deserve close monitoring.” It noted indicators that signal a decline in banks’ interest, fee and trading income. While this could partially be attributed to low rates, provisioning related to non-performing loans also needs to be taken into consideration, it said.
Officials said further challenges could arise from regulatory and supervisory demands in coming months, but “prevailing misperceptions regarding adverse implications for the banking sector of regulatory measures and supervisory action” had to be countered.