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EMU CommentECB in mild dovish shift, with TLTRO III less generous than last round

  1. ECB in mild dovish shift, with TLTRO III less generous than last round
  2. Draghi warns eurozone risks tilted to the downside; tiering unlikely without further guidance changes
  3. Inflation outlook pressures an ECB expecting extensive personnel changes
ECB in mild dovish shift, with TLTRO III less generous than last round
In its June meeting, the ECB Governing Council voted unanimously to keep its key rates unchanged, as expected: the interest rates on the main refinancing operations, the marginal lending facility and the deposit facility remain at 0.00%, 0.25% and -0.40% respectively. Also unchanged, reinvestments of maturing securities purchased under the asset purchase programme will continue for an extended period of time, past the date when it first raises the key ECB interest rates and for as long as necessary to maintain favourable liquidity conditions. The ECB amended its forward guidance and now expects the key ECB interest rates to remain at their present levels at least through the first half of 2020, whereas previously it expected rates to remain at present levels throughout 2019. The bank disclosed new information on the targeted longer-term refinancing operations (TLTRO III): “the interest rate in each operation will be set at a level that is 10 basis points above the average rate applied in the Eurosystem’s main refinancing operations over the life of the respective TLTRO. For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III will be lower and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation plus 10 basis points.” That implies a range of +0.1% to -0.3% at the current levels of the two policy rates, and is 10bp higher than for the previous version of TLTRO. The initial market reaction within five minutes of the release of the decision were mixed: the Euro Stoxx 600 Index and the Euro Stoxx 600 Banks index fell by -0.3% and -0.2% respectively; yields on German and Italian ten-year sovereign bonds increased by 1.1bp and 3.8bp respectively; whereas the euro appreciated by 0.23%.
Draghi warns that eurozone risks tilted to the downside; tiering unlikely without further guidance changes
In his statement, Draghi noted that global headwinds still weigh on the eurozone outlook and that “geopolitical uncertainties, rising protectionism threats and vulnerabilities in emerging markets leave their mark on economic sentiment.” He also noted that “the positive contribution of negative interest rates to the accommodative monetary policy stance and to the sustained convergence of inflation is not undermined by possible side effects on bank-based intermediation.” In the Q&A session, Draghi did not close the door completely and signaled that mitigating measures could be needed if the ECB extends its forward guidance further. He also stated that the ECB has "considerable headroom" on QE, after holding back in recent months. In his statements, Draghi also noted that even though measures of underlying inflation remain generally muted, “ labour cost pressures continue to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets” and, over the medium term, underlying inflation is expected to increase, “supported by our monetary policy measures, the ongoing economic expansion and stronger wage growth.” In line with this, the ECB’s new macroeconomic projections were revised up by 0.1 percentage points for 2019 and revised down by 0.1 percentage points for 2020. In addition, projections for GDP growth for 2020 and 2021 were revised downward by 0.2 and 0.1 percentage points respectively (see table below).
Inflation outlook pressures an ECB expecting extensive personnel changes
Our house view is that the ECB will keep key rates unchanged over the coming three years, in line with a continued slowdown mapped out in our April Global Macro Forecast, “Meagre shelter for the global economy”. Despite a higher-than-expected first quarter GDP release, inflation risks remain to the downside, as long-run market expectations continue to trend lower and recent inflation data prints remain muted. Market-participant discussions over tiered interest rates, a possible return to QE and the overall scope of the ECB’s toolkit are likely to continue. Meanwhile, in our view, the ECB has a historical bias toward “keeping its power dry” and will be likely be slow to react. Beyond the tenure of ECB president Draghi coming to an end in October, the significant turnover in the Governing Council (we expect 10 of the 26 seats to change this year) is likely to have some effect on decision-making ahead. That has the possibility of not only altering the balance between doves and hawks, but it could also affect the preferences of the council as a whole for the composition and scope of non-standard policy measures, as well as tilt the group’s reaction function to prevailing risks to the inflation outlook.


Source: ECB


 Erik Meyersson

Erik Meyersson

Senior Economist


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