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Central banks 26 Dec 2017

The ECB’s new monetary policy in 2018: good prospects for everyone

The beginning of the normalization of monetary policy in 2018 should bring greater profitability for banks, a larger investor appetite and a positive outlook for the stock market. However, what is perhaps more important, the new policy will enable banks to meet one of their principal goals: supporting economic growth by financing companies and private individuals.

Following the October 2017 announcement by the European Central Bank that it will reduce asset purchases – better known as Quantitative Easing (QE) – starting in January 2018, everything indicates that the coming year will see the normalization of its monetary policy. Likewise, in the absence of financial tensions or unexpected events, the markets will anticipate an increase in interest rates in 2018.

This is what José Manuel González-Páramo predicted, in a column published by the Prensa Ibérica newspaper group, entitled: “The Withdrawal of the Stimulus by the BCE: Suitable for Everyone.” BBVA’s executive director and head of economy, regulation and institutional relations, foresees a gradual withdrawal of the stimulus and doesn’t expect an increase in rates until mid-2019. In his opinion, the year that is about to begin will mark a turning point for Europe’s financial markets.

Maintaining [negative interest rates] for an excessively long period jeopardizes families, companies and financial stability”

José Manuel González-Paramo recalled that after several years of negative interest rates, European financial markets will go back to operating in a “normal” context. “Negative interest rates clearly are not (normal),” he wrote. “Maintaining them for an excessively long period jeopardizes families, companies and financial stability.”

One of the greatest beneficiaries of this possible increase in rates will be the financial sector. As José Manuel González-Páramo explains in this column, banks will see an increase in their profitability after more than five years of declines in the euroibor. The impact will be more positive for those banks in which the retail business and variable rate loans predominate, which is the case of Spanish banks.

Having a solid, solvent and profitable financial system benefits both its shareholders and its customers”

It’s true that an interest rate increase would mean higher interest payments for companies and private individuals. However, economic growth and job creation, along with the gradual deleveraging of the private sector, will tend to counteract this effect.

González-Páramo is sure that Europe’s finance sector will begin to emerge from the tunnel after more than 10 years of crisis. He reiterated: “Having a solid, solvent and profitable financial system benefits both its shareholders and its customers”.

Rueda de prensa del Banco Central Europeo (BCE) el 14 de diciembre de 2017.

What lies ahead for the ECB in 2018?

It faces a twin challenge: on the one hand, adjusting monetary conditions to the positive economic environment – with the European economy growing at a 2% annual rate and an expected increase in inflation from the current 1.4% annual rate. And on the other hand, avoiding an overreaction by fixed income securities and the euro.ç

The prudence shown in the gradual recalibration of the asset purchase program minimizes the risk of an overreaction in the market”

The BCE’s principal objective is to achieve financial stability. A strong appreciation of the euro against the dollar, such as that seen in recent months, due to the improved outlook for the European economy, could lower the prospects for inflation and have a negative impact on eurozone exports. In this context, in González-Páramo’s opinion, “the prudence shown in the gradual recalibration of the asset purchase program minimizes the risk of an overreaction in the market.”

With regards to the year to come, the evolution of prices in the euro zone and ultimately, any variable that affects them, are the key issues the ECB will be monitoring.

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