ECB Press Statement Comparison between February 2014 and March 2014

ECB Press Statement Comparison between February 2014 and March 2014

Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. Incoming information confirms that the moderate recovery of the euro area economy is proceeding in line with our previous assessment. At the same time,underlying price pressures in the euro area remain weak andlatest ECB staff macroeconomic projections, now covering the period up to the end of 2016, support earlier expectations of a prolonged period of low inflation, to be followed by a gradual upward movement in HICP inflation rates towards levels closer to 2%.

In keeping with this picture, monetary and credit dynamics are remain-subdued. Inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.As stated previously, we are now experiencing a prolonged period of low inflation, which will be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on.

Regarding the medium-term outlook for prices and growth, further theinformation and analysis will become now available in early March. Recent evidence fully confirm our decision to maintain an accommodative monetary policy stance for as long as necessary. Thiswill assist the gradual economic recovery in the euro area. We firmly reiterate our forward guidance.

Inflation

We continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy, the high degree of utilized capacity and subdued and credit creation.

We are monitoring developments on money markets closely and are ready to consider all available instruments available to us. Overall, we remain firmly determined to maintain the high degree of monetary accommodation and to take further decisive action if required.

Let me now explain our assessment in greater detail, starting with the economic analysis. Real GDP in the euro area rose by 0.3%, quarter on quarter, in the last quarter of 2013., thereby increasing for three consecutive quarters. Developments in survey-based confidence indicators up to February are consistent with continued moderate growth also in the first quarter of this year. Looking ahead, the ongoing recovery is expected to proceed, albeit at a slow pace.

In particular, some further improvement in domestic demand should materialize, supported by the accommodative monetary policy stance, improving financing conditions and the progress made in fiscal consolidation and structural reform. In addition, real incomes are supported by lower energy prices. Economic activity is also expected to benefit from a gradual strengthening of demand for euro area exports. At the same time, although unemployment in the euro area is stabilizing, it remains high, and the necessary balance sheet adjustments in the public and the private sectors will continue to weigh on the pace of the economic recovery.

euro area exports

This assessment is also broadly reflected in the March 2014 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP increasing by 1.2% in 2014, 1.5% in 2015 and 1.8% in 2016. Compared with the December 2013 Euro-system staff macroeconomic projections, the projection for real GDP growth for 2014 has been revised slightly upwards.

The risks surrounding the economic outlook for the euro area continue to be on the downside. Developments in global financial markets and in emerging market economies, as well as geopolitical risks, may have the potential to affect economic conditions negatively. Other downside risks include weaker than expected domestic demand and export growth and insufficient implementation of structural reforms in euro area countries.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.8% in February 2014, unchanged from the (upwardly revised) outcome for January. While energy prices fell more strongly in February than in the previous month, increases in industrial goods and services prices were higher than in January. On the basis of current information and prevailing futures prices for energy, annual HICP inflation rates are expected to remain at around current levels in the coming months. Thereafter, inflation rates should gradually increase and reach levels closer to 2%, in line with inflation expectations for the euro area over the medium to long term.

euro area annual HICP inflation

This assessment is also broadly reflected in the March 2014 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.0% in 2014, 1.3% in 2015 and 1.5% in 2016. In the last quarter of 2016, annual HICP inflation is projected to be 1.7%. In comparison with the December 2013 Eurosystem staff macroeconomic projections, the projection for inflation for 2014 has been revised slightly downwards.

In view of the first publication of a three-year projection horizon in the March 2014 ECB staff macroeconomic projections, it should be stressed that the projections are conditional on a number of technical assumptions, including unchanged exchange rates and declining oil prices, and that the uncertainty surrounding the projections increases with the length of the projection horizon.

Regarding the Governing Council’s risk assessment, both upside and downside risks to the outlook for price developments are seen as limited, and are considered to be broadly balanced over the medium term.

Turning to the monetary analysis, data forJanuary 2014 confirm the assessment of subdued underlying growth in broad money (M3) and credit. Annual growth in M3 increased to 1.2% in January, from 1.0% in December, . The monthly inflow to M3 in January was substantial, compensating for the strong outflow in December The increase in M3 growth reflected a stronger annual growth rate of M1, which rose to 6.2% from 5. 7% in December. As in previous months, the main factor supporting annual M3 growth was an increase in the MFI net external asset position, which continued to reflect the increased interest of international investors in euro area assets.

The annual rate of change of loans to the private sector continued to contract. The annual rate of change of loans to non-financial corporations (adjusted for loan sales and securitisation) was -2.9% in January, unchanged from December. Weakloan dynamics for non-financial corporations continue to reflect their lagged relationship with the business cycle, credit risk and the ongoing adjustment of financial and non-financial sector balance sheets. The annual growth rate of loans to households (adjusted for loan sales and securitisation) stood at 0.2% in January 2014, broadly unchanged since the beginning of 2013.

financial and non-financial sector balance sheets

Since the summer of 2012 substantial progress has been made in improving the funding situation of banks. In order to ensure an adequate transmission of monetary policy to the financing conditions in euro area countries, it is essential that the fragmentation of euro area credit markets declines further and that the resilience of banks is strengthened where needed. This is the objective of the ongoing comprehensive assessment by the ECB, while a  timely implementation of additional steps to establish a banking union will further help to restore confidence in the financial system.

To sum up, the economic analysis confirms our expectation of a prolonged period of low inflation, to be followed by a gradual upward movement towards levels of inflation closer to 2%. A cross-check with the signals from the monetary analysis confirms the picture of subdued underlying price pressures in the euro area over the medium term.

As regards fiscal policies, the ECB staff macroeconomic projections indicate continued progress in reducing fiscal imbalances in the euro area. The aggregate euro area general government deficit is expected to have declined to 3.2% of GDP in 2013 and is projected to be reduced further to 2.7% of GDP this year. General government debt is projected to peak at 93.5% of GDP in 2014, before declining slightly in 2015.

Looking ahead, euro area countries should not unravel past consolidation efforts and should put high government debt ratios on a downward trajectory over the medium term. Fiscal strategies should be in line with the Stability and Growth Pact and should ensure a growth-friendly composition of consolidation which combines improving the quality and efficiency of public services with minimizing discretionary effects of taxation. National authorities should also continue with the decisive implementation of structural reforms in all euro area countries.

These reforms should aim, in particular, to make it easier to do business and to boost employment, thus enhancing the euro area’s growth potential and reducing unemployment in the euro area countries. To this end, the Governing Council welcomes the European Commission’s communication of yesterday on the prevention and correction of macroeconomic imbalances and on the Excessive Deficit Procedure. Looking ahead, it is key that the macroeconomic surveillance framework in the euro area, which was significantly strengthened in the wake of the sovereign debt crisis, is implemented fully and in a consistent manner.

macroeconomic surveillance framework

We are now at your disposal for questions.

January 2014 Governing Council Press Statement Track Changes

January 2014 Governing Council Press Statement Track Changes

Statement Comparison between January 2014 and December 2013

ECBwatchers.org

Ladies and gentlemen, the Vice-President and we are very pleased to welcome you to our press conference.Let me wish you all a Happy New Year. I would also like to take this opportunity to welcome Latvia as the eighteenth country to adopt the euro as its currency. Accordingly, Mr Rimšēvičs, the Governor of Latvijas Banka, became a member of the Governing Council on 1 January 2014. We will now report on the outcome of today’s meeting of the Governing Council.

Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. Incoming information and analysis have  continued to confirm our previous assessment. Underlying price pressures in the euro area are expected to remain subdued over the medium term. In keeping with this picture, monetary and credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term are firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.

Such a constellation continues to suggest that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. Against this background, the Governing Council strongly emphasizes that it will  maintain an accommodative stance of monetary policy for as long as necessary,  which will assist the gradual economic recovery in the euro area. Accordingly, we firmly reiterate our forward guidance that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time.

As previously stated, this expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy and subdued monetary dynamics. With regard to money market conditions and their potential impact on our monetary policy stance, we are monitoring developments closely and are ready to consider all available instruments. Overall, we remain determined to maintain the high degree of monetary accommodation and to take further decisive action if required.

Gov_Council

Let me now explain our assessment in greater detail, starting with the economic analysis. Real GDP in the euro area rose by 0.1%, quarter on quarter, in the third quarter of 2013, following an increase of 0.3% in the second quarter. While developments in industrial production data for October point to a weak start to the fourth quarter, survey-based confidence indicators up to December have improved further from low levels, overall indicating a continuation of the gradual recovery in economic activity.

Looking at 2014 and 2015, output is expected to recover at a slow pace, in particular owing to some improvement in domestic demand supported by the accommodative monetary policy stance. Euro area economic activity should, in addition, benefit from a gradual strengthening of demand for exports. Furthermore, the overall improvements in financial markets seen since the summer of 2012 appear to be working their way through to the real economy, as should the progress made in fiscal consolidation.

In addition, real incomes have benefited recently from lower energy price inflation. At the same time, unemployment in the euro area remains high, and the necessary balance sheet adjustments in the public and the private sector will continue to weigh on economic activity.

The risks surrounding the economic outlook for the euro area continue to be on the downside. Developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions. Other downside risks include higher commodity prices, weaker than expected domestic demand and export growth, and slow or insufficient implementation of structural reforms in euro area countries.

 

economy and subdued monetary dynamics

According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.8% in December 2013, compared with 0.9% in  November. This outcome was broadly as expected and reflected lower services price inflation. On the basis of prevailing futures prices for energy, annual inflation rates are expected to remain at around current levels in the coming months. Over the medium term, underlying price pressures in the euro area are expected to remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.

The risks to the outlook for price developments continue to be seen as broadly balanced over the medium term, with upside risks relating to higher commodity prices and stronger than expected increases in administered prices and indirect taxes,  and downside risks stemming from weaker than expected economic activity.

Turning to the monetary analysis, data for  November support the assessment of continued subdued underlying growth in broad money (M3) and credit. Annual growth in M3 was broadly unchanged at 1.5% in November, after 1.4% in October,  following two consecutive declines in September and August. Annual growth in M1 remained strong at 6. 5%, reflecting a preference for liquidity, although it was below the peak of 8.7% observed in April 2013. As in previous months, the main factor supporting annual M3 growth  was an increase in the MFI net external asset position, which continued to reflect the increased interest of international investors in euro area assets.

The annual rate of change of loans to the private sector remained weak. The annual growth rate of loans to households (adjusted for loan sales and securitisation) stood at 0.3% in November, broadly unchanged since the beginning of  2013. The annual rate of change of loans to non-financial corporations (adjusted for loan sales and securitisation) was 3.1% in November, following -3.0% in October. Overall, weak loan dynamics for non-financial corporations continue to reflect their lagged relationship with the business cycle, credit risk and the ongoing adjustment of financial and non-financial sector balance sheets.

annual rate of change of loans to non-financial corporations

 

Since the summer of 2012 substantial progress has been made in improving the funding situation of banks. In order to ensure an adequate transmission of monetary policy to the financing conditions in euro area countries, it is essential that the fragmentation of euro area credit markets declines further and that the resilience of banks is strengthened where needed.

The forthcoming comprehensive assessment by the  ECB will further support this confidence-building process. It will enhance the quality of information available on the condition of banks and result in the identification and implementation of necessary corrective actions.  A timely implementation of further steps to establish a banking union will help to restore confidence in the financial system.

To sum up, the economic analysis indicates that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. A cross-check with the signals from the monetary analysis confirms this picture.

As regards fiscal policies, it is important not to unravel past efforts but to sustain fiscal consolidation over the medium term. Fiscal strategies should be in line with the fiscal compact and should ensure a growth-friendly composition of consolidation, which combines improving the quality and efficiency of public services with minimizing distortionary effects of taxation.

When accompanied by the decisive implementation of structural reforms, this will further support the gradual economic recovery in the euro area and have a positive impact on public finances. Reforms in product and labour markets and a rigorous enactment of Single Market policies warrant particular focus to improve the outlook for economic growth and to foster job creation in an environment of high unemployment.

Fiscal strategies

 

We are now at your disposal for questions.

 

Changes in the Draghi speech at Jackson Hole

Changes in the Draghi speech at Jackson Hole

Draghi speech at Jackson Hole

Draghi pronounced a pretty major speech at Jackson Hole but the delivery of the speech has been marred by a controversy over changes he would have introduced himself compared to the original version of the speech (which was momentarily posted on the ECB’s website).

There are several interpretations about the origin of these changes: whether they respond to the climate there and the friendly peer pressure he might have received there. Or whether they are part of a more deliberate strategy to go beyond what his services had prepared in order to push both his Executive Board and the Governing Council further.

But the changes are pretty unequivocal on the assessment but more prudent on the action to take. Indeed, while Draghi qualifies the risk of disanchoring of inflation expectations, which really accelerated only in august. He is more cautious on the policy conclusions where he repeats the agreed language on “all instruments” rather specifically “unconventional instruments”.

ECB and the treatment of sovereign debt

ECB and the treatment of sovereign debt

Peter Praet gave an interview to the Financial Times this morning where he made a very important point about sovereign debt holdings (full transcript without the paywall courtesy of the ECB here):

The worst case, to say it very bluntly, is of a central bank providing liquidity to banks just to buy or carry legacy assets, and the banking sector doesn’t restructure. This was typically the Japanese situation in the early 2000s.

Perhaps paradoxically, a rigorous AQR and stress test helps monetary policy. Appropriately treating banks’ holdings of sovereign debt according to the risk that they pose to banks’ capital makes it unlikely that the banks will use central bank liquidity to excessively increase their exposure to sovereign debt. This is because banks will be wary of the constraints placed on sovereign debt by the stress tests to which they are subject at the same time.

The ECB had expressed dissatisfaction about the fact that the previous round of LTRO had been used to buy sovereign bonds and offered banks with an easy carry trade which in turn contributed to increase financial fragmentation and the sovereign-banks nexus as banks hoarded domestic government bonds. This is now described as an unintended consequence that needs to be addressed. This was a critical point made by Jens Weidmann in a recent OpEd in the FT and it is also something that has been at the heart of discussions in the context of the AQR and the ESRB.

easy carry trade

There are two very different problems here that should be distinguished:

The first is the increase in sovereign debt holdings in aggregate and this is hardly an unintended consequences, this was actually precisely the point of the LTRO. Get banks to hold assets because their liquidity risks were taken care of. The LTRO were designed both to stabilize sovereign debt markets and loosen monetary conditions, in that sense they have worked pretty well, driving government funding pressures and affected yields across the credit spectrum.

The second is the concentration of domestic debt, (ie. the renationalisation of debt holdings). This is the real unintended consequence. The ECB probably didn’t anticipated so much national hoarding. But this can easily be controlled by diversification/concentration caps on sovereign debt holdings. This is actually something the ECB could impose as a single supervisor, via the European Systemic Risk Board or in the context of the AQR but this is very different from imposing capital surcharges or haircuts on sovereign debt in repo operations.

sovereign debt holdings

Conclusion

It is critical that the ECB differentiates the problem of large holdings of sovereign debt (quite normal in high risk aversion environment) from high domestic concentration of sovereign debt holdings. These are two different issues. Confusing both will lead the ECB to:

  • tighten monetary condition at the worse possible moment
  • weaken the transmission channels via the refinancing operations of government debt
  • destabilise government debt markets by exacerbating already challenging funding conditions for sovereigns
  • weaken banks’ profitability and increase risks to financial stability
Fiscal devaluation without wage growth will trigger bad side effects both at home and abroad.

Fiscal devaluation without wage growth will trigger bad side effects both at home and abroad.

“Restoring competitiveness via structural reforms,” as the mantra goes, has in practice been a policy not so much geared toward creating productivity gains but rather designed to pursue wage and price reductions to boost exports. When these nominal or real reductions in wages were difficult to secure politically, they were replaced by fiscal devaluations, shifting taxes away from labor toward indirect taxes. It’s a policy that mimics an exchange-rate devaluation by modifying relative prices.

In effect, Europe has replaced the competitive exchange-rate devaluations of the 1970s and 1980s with wage compression and fiscal devaluations within the euro. The result is a policy race to the bottom that spreads deflation inside and outside the euro area. Even a country like Finland, which stands at the top of every competitiveness and ease-of-doing-business indicator, has now convinced itself that the best way to lift itself out of a three-year recession is to restore price competitiveness through a reduction in hourly wages.

The collective effect of this policy weighs heavily on aggregate demand and fuels deflationary forces. It also undermines the European Central Bank’s objective of achieving 2% inflation through low interest rates and purchases of sovereign bonds and other assets.

current-account surplus

 

The European Commission’s macroeconomic-imbalances procedure, which was established during the crisis to allow the better coordination of national economic policies, has so far been a failure. It has proved ineffective for spotting excessive deficits and impotent in confronting excessive surpluses.

The eurozone needs to address its internal and external imbalances more seriously. This can’t be achieved by fiscal consolidation, structural reforms and devaluations. It has to involve not only fiscal expansion in countries that can afford it most, but also a sustained rise in wages across the euro area to boost domestic demand.

The inability to do so is no longer simply a problem for the euro-zone itself. It’s a matter of global relevance. The eurozone’s current-account surplus is now 3.7% of GDP, the largest in the world in absolute terms, and it’s expected to remain at such elevated levels over the next few years. A possible new round of monetary accommodation by the ECB could increase it even further.

Indeed, a depreciation of the euro would only be expansionary for the whole world if the effects on domestic demand and financial conditions in the euro-zone were greater than the contractionary side-effect of appreciating other currencies in the rest of the world. Yet monetary policy alone, at least in the near term, won’t be able to countervail the demand-suppressing consequences of lower wages and debt deleveraging.

currency

The debate on the degree to which Europe’s policy failure has become a global one hasn’t really started. The International Monetary Fund and the G-20 statements remain too kind and international pressures too limited.

Since the height of the crisis, the matter of global imbalances has receded and international coordination on the matter has declined. The IMF expects the U.S. current-account deficit to have shrunk by nearly half compared to 2007 levels. China’s slow rebalancing has brought the current-account surplus down to 3% of GDP from 10%.

Meanwhile, the U.S. and China seem to have found at least a transitory monetary peace, a pax chimericana: the U.S. government will agree to China’s newly created Asia Infrastructure Investment Bank and entry into the IMF’s special drawing rights basket of currencies, while China will try to maintain a relatively stable currency to prevent another round of rapid appreciation of the dollar.

This policy coordination between the world’s two leading economic powers seems far more developed and effective than what’s happening within the G-20 and surely within the euro-zone. And yet, the case against the eurozone’s macroeconomic policy is unlikely to be made effectively at the forthcoming G-20 summit in Turkey because it is politically charged and directly linked to the dysfunctional governance of the monetary union.

In Europe, there hasn’t been a meaningful discussion on macroeconomics since ECB President Mario Draghi’s Jackson Hole speech last year. The fiscal question remains largely taboo, and the policy consensus is that economic reforms and currency devaluation can somehow kick-start and sustain the recovery. Both the empirical and theoretical evidence suggest the opposite.

economic reforms

The euro-zone and its member states can’t continue to behave as if they were a small, open economy. It’s a mistake for the G-20 to let the eurozone continue to free ride and undermine the increasingly fragile global recovery.

Mr. Vallée, a former adviser to the French economy minister and the president of the European Council, is a senior economist at Soros Fund Management LLC.