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Analysis and opinion 09 Mar 2016

ECB monetary policy meeting: 5 key points to take into account

After the words of Mario Draghi at the January meeting, leaving the door open to expand the measures of the European Central Bank this month, these are BBVA Research forecasts for the meeting tomorrow.

1. ECB will act at Thursday meeting …

At its 10 March meeting, we expect the ECB will ease its policy, announcing another package of measures, in response to the deterioration of the economic outlook. The ECB will revise significantly downwards its inflation forecasts. In particular, the central bank considers that the impact of external factors and heightened uncertainty are raising the possibility current measures might not be enough to achieve its objective for inflation rates.

2. … there is significant support to recalibrate the current stance of monetary policy accommodation

The minutes of its 21 January meeting, comments from ECB governing council members and the recent financial market turmoil particularly affecting the banking system support further action at Thursday´s monetary policy meeting. In this context, ECB dovish members, led by its president, Mario Draghi, reasserted their readiness to expand the stimulus. In particular, he said that the ECB will not surrender to low inflation and he warned that “the risks of acting too late outweigh the risks of acting too early.”

3. More stimuli accompanied by a significant downward revision of inflation forecasts

At this meeting, the ECB will update its projections, which will be crucial for Thursday’s monetary policy decision. In regard to activity, the worsening incoming data (especially weaker foreign demand) along with higher global and idiosyncratic financial uncertainty might lead to a downward revision of GDP growth of around 0.3pp this year, from the 1.7% projected last December. But we do not expect any significant changes for the 2017 projection of 1.9%, and probably an unchanged figure for 2018. More importantly, we think inflation forecasts will be revised down significantly, mainly driven by the sharp fall in oil prices since last December. We see a significant downward revision by a bit less than 1pp for 2016 (from the 1% previously projected) and 0.2pp for 2017 (from 1.6% previously), while meeting the inflation target should be delayed until 2018 (according to our forecasts).

4. A new package of easing measures to be delivered…

We consider that an extension of the asset purchase programme (APP) until at least September 2017 could be one of the preferred options (given the bank’s implicit commitment to keeping rates low for longer). We also expect changes in the technical parameters of the APP to coincide with the semiannual revision of the APP.

We also expect that the central bank will cut the interest rate on its deposit facility further into negative territory, to -0.4%. In order to mitigate the immediate direct impact on banks, the ECB would likely implement a tiered deposit rate. In particular, Benoît Coeuré and vice president Vitor Constancio expressed concern about the impact of negative rates on the banking sector, stressing that the central bank would aim to protect banks if it decides to ease its monetary policy even further.

Finally, the central bank could also ease conditions on TLTROs. However, we do not dismiss more aggressive action on the part of the central bank, i.e., a 20 bps deposit rate cut, further TLTROs or significantly increase the pace of asset purchases.

5. … taking care not to disappoint markets

Market expectations on the ECB are very high. This expectation of further easing has pushed (slightly) down both the euro and the European curve, mainly the monetary rates. If the ECB disappoints at the March meeting, this market effect could be reversed. Therefore, apart from the announcement of the new package, the ECB is expected to retain a very dovish communication. Although the cyclical situation and the fragility of the recovery justify continuing a highly accommodating monetary policy, the fact is that the ECB has less and less margin for maneuver and, more importantly, the effectiveness of additional measures is decreasing or even  questioned –for the case of negative interest rates.

 

*Sonsoles Castillo is Financial Scenarios Chief Economist at BBVA Research

*María Martínez is Senior Economist at BBVA Research

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