ECB Sends a Dovish Message

The European Central Bank (ECB) held interest rates and asset purchases steady on Thursday, amid speculation that the bank will start to scale back its ultra-loose monetary policy in the fall.

The central bank said that economic conditions remained positive but attempted to calm markets by striking a somewhat dovish tone and insisting that it would be poised to step in should the outlook take a downward turn.

“If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the program in terms of size and/or duration,” the ECB said in its policy announcement alongside its latest rate decision.

The euro dropped to $1.1489 against the dollar on the news, losing some of the gains recorded in recent weeks. The pan-European Euro Stoxx 600 index extended gains a little on the announcement and yields on the 10-year German bund also pushed lower.

Many market participants expect that improved economic growth in the euro zone will cause a shift away from years of easy money, where interest rates have been held at 0.00 percent for seventeen consecutive months.

Widely anticipated

The lack of movement on rates on Thursday was widely anticipated, but ECB President Mario Draghi will have a thin line to tread in a press conference later in the session. He is expected to speak about this anticipated policy shift from the ECB, but not cause undue panic in asset markets.

Markets were shaken last month by hawkish comments from Draghi which suggested that the bank would steam ahead with interest rate hikes and the reduction of its bond-buying program – schemes used to inject cash into the economy. During an ECB Forum in Sintra, Portugal, in June, Draghi said that “all the signs now point to a strengthening and broadening recovery in the euro area” and added the bank would need to be “persistent” and “prudent” in adjusting its parameters going forward.

The comments initiated a mini tantrum in financial markets as they caught a glimpse of the winding down of the unprecedented central bank stimulus which has characterized the last decade since the global financial crisis.

They came just weeks after the ECB’s monthly policy meeting in which it dropped its reference to future rate cuts but insisted that interest rates could be expected to “remain at present levels for an extended period of time.”

Since then, the ECB has resisted overtly backtracking on Draghi’s comments, in a bid to avoid confusing markets further, but it has been careful to temper its comments so as to prevent an unwanted tightening of monetary conditions. Thursday’s dovish message was another example of that.

‘Taper’ next year?

UBS’s Chief Economist Reinhard Cluse told CNBC Thursday, ahead of the announcement, that he expected the bank to announce the gradual winding down of its quantitative easing (QE) program on September 7, when policymakers return from summer recess.

He said this is likely to kick off in January next year and run until the end of the summer. This program will be followed later by interest rate hikes.

“We think it’s a program that will take six to nine months, so by the summer or late-summer of 2018 that tapering program will be complete. We think interest rate hikes will come as of 2019 but proceed very gradually and in a data-dependent fashion. In the meantime we think the ECB will keep liquidity conditions very easy,” Cluse said.

However, he insisted that the shifting of money market rates could be a “multi-year process.”

Oliver Brennan, senior macro strategist at TS Lombard, agreed that the tapering could be expected at an average pace of $10 billion per meeting, which would enable its completion in the third quarter of next year.

The ECB’s shifting stance shadows that laid out before it by the U.S. Federal Reserve, which has been gradually raising interest rates on the back of a strengthening economy.

Fed Chair Janet Yellen announced at the central bank’s monthly meeting last week that U.S. interest rates were reaching “neutral” levels and any further hikes would be gradual.

CNBC

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