Thursday, May 6, 2010

ECB Stays Put, Comfortable With Balance of Risks

The European Central Bank announced no change to the policy rate (at 1%); and in spite of pressure to do otherwise, also no changes to other monetary policy moves. With the fiscal problems surfacing in the EU (most notably Greece), there had been some expectations that the ECB might e.g. "go nuclear"... implementing extraordinary measures, but for now it seems the ECB doesn't see this as necessary. Before moving into the economic analysis part it's worth reviewing what they did say in this respect (given the topical nature of fiscal challenges):
"As regards fiscal policies, we call for decisive actions by governments to achieve a lasting and credible consolidation of public finances. The latest information shows that the correction of the large fiscal imbalances will, in general, require a stepping-up of current efforts. Fiscal consolidation will need to exceed substantially the annual structural adjustment of 0.5% of GDP set as a minimum requirement by the Stability and Growth Pact.

The longer the fiscal correction is postponed, the greater the adjustment needs become and the higher the risk of reputational and confidence losses. Instead, the swift implementation of frontloaded and comprehensive consolidation plans, focusing on the expenditure side and combined with structural reforms, will strengthen public confidence in the capacity of governments to regain sustainability of public finances, reduce risk premia in interest rates and thus support sustainable growth over the medium term.

In this context, the Governing Council welcomes the economic and financial adjustment programme which was approved by the Greek government following the successful conclusion of the negotiations with the European Commission, in liaison with the ECB, and the International Monetary Fund, with a view to safeguarding financial stability in the euro area as a whole."
So the ECB does see fiscal challenges as a problem, but it's comfortable limiting its official monetary policy stance as verbal for now (other than the moves announced earlier this week). So the name of the game is holding the rounds in the clip - the ECB still maintains the capacity to act if need be. For instance it could drop the rate from 1% to parity with the Fed's 0 to 0.25%, and it could also take the 'nuclear option' of an aggressive "quantitative easing" financial market intervention program. So it is comforting to know that 1. they have the capacity to act; and 2. they don't see a need to act (yet).

Now, onto the usual concerns; inflation is currently viewed as being "contained" in the EU. On the inflationary side there's upward pressure from commodity prices and faster growing (mostly developing) economies. But meanwhile the EU economy is broadly still struggling along (albeit recording some growth in some regions) so on balance the view is that inflation is not a near term problem in the EU:
"Taking into account all new information since our meeting on 8 April 2010, we expect price developments to remain moderate over the policy-relevant horizon. Global inflationary pressures – driven mainly by price developments in commodity markets and in fast-growing economic regions of the world – are still being counteracted by low domestic price pressures. The latest information has also confirmed that the economic recovery in the euro area continued in the early months of 2010. We expect the euro area economy to expand at a moderate pace in 2010, but growth patterns could be uneven in an environment of high uncertainty.

Our monetary analysis confirms that inflationary pressures over the medium term remain contained, as suggested by weak money and credit growth. Overall, we expect price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households. Inflation expectations remain firmly anchored in line with the Governing Council’s aim of keeping inflation rates below, but close to, 2% over the medium term. The firm anchoring of inflation expectations remains of the essence."
So for now, no move is probably the right move. Growth will, in aggregate, continue in the Euro Area, but as noted previously it will be fragile, gradual and uneven. The usual risks of faster than expected increases in commodity prices, protectionist pressures and disorderly unwinding of global imbalances remain. So the outlook for the EU is, if muted, at least mildly positive; and as far as fiscal challenges go, one can only hope the ECB doesn't have do anything more.

Econ Grapher Analytics
European Central Bank
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