Bottom Line: as Goldman summarizes, the Governing Council left all key policy parameters unchanged at today’s meeting, as expected, but operationalized its new monetary policy strategy by updating the forward guidance language in the Monetary Policy Decision (released at 12.45pm CET) and the new Monetary Policy Statement (read out at 1.30pm CET).
Rate lift-off is now conditional on inflation being forecast to reach 2% “well ahead of the end of the projection horizon.” President Lagarde emphasized that the new guidance reflected the ECB’s commitment to compensate for limited easing room with greater persistence, and to tolerate “a transitory period in which inflation is moderately above target.” In other words, a policy similar to the Fed's FAIT, no matter how much the ECB will deny it.
Beyond guidance changes, the Council saw the Euro area on track for strong growth in Q2 and Q3 (with balanced risks), but did not discuss QE at this meeting. With the baseline outlook still intact, Goldman continues to look for a reduction of the PEPP purchase pace at the September meeting for Q4 back to Q1 levels.
- The Governing Council left all key policy parameters unchanged at today’s meeting,as widely expected. It maintained the overall envelope of its pandemic emergency purchase programme (PEPP) at EUR1.85 trillion, and reiterated that it will conduct net asset purchases under the PEPP until at least the end of March 2022, with risks to the envelope remaining two-sided. The Governing Council repeated its forward guidance that rates will remain at current or lower levels until the inflation outlook has improved sufficiently.
- But the Council updated both the format and substance of its policy communication to operationalize its new monetary policy strategy. In terms of format, the Monetary Policy Decision released at 12.45pm (London) changed little,but the Introductory Statement was replaced with a Monetary Policy Statement,read out by President Lagarde at 1.30pm (London). The new statement is substantially shorter and presents a joint narrative that integrates the economic,monetary and financial analyses.
- In terms of substance, the Council redefined its forward guidance to align it with the strategy review by guiding that it expects to keep policy rates on hold until it has seen “inflation reaching two per cent well ahead of the end of the projection horizon and durably for the rest of the projection horizon.” The Council is further looking for progress in underlying inflation towards the new target to be “sufficiently advanced.”President Lagarde emphasized that the new guidance reflected the ECB’s commitment to compensate for limited easing room with greater persistence. Finally, the ECB referenced its new overshooting bias by highlighting that more persistent accommodation may imply “a transitory period in which inflation is moderately above target.”
- Beyond guidance changes, the new Monetary Policy Statement describes the Euroarea outlook as broadly unchanged since the June Governing Council meeting with growth on track to be strong in Q2 and Q3. The ECB continued to see balanced risks around the growth outlook, with consumer spending potentially accelerating the rebound, whereas the spread of the Delta variant was seen as a risk particularly to the bounce-back in the services sector. The Council continues to judge the pick-up in inflation to remain transitory as underlying inflation was held back by still-elevated slack.
- While President Lagarde again deemed a discussion on PEPP as “totally premature”at this meeting, Goldman expects the Governing Council to adjust the Q4 PEPP pace at its September meeting back towards the Q1 pace. The September meeting might also bring a more concrete discussion of the conditions that will ultimately be required for PEPP to end, which we expect to center around the robustness of the recovery.
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As expected, the ECB has left its rates and key policy metrics (QE) unchanged, while vowing to maintain a persistently accommodative monetary policy stance to meet its inflation target. No surprises there. Other unsurprising announcements:
- ECB Leaves Main Refinancing Rate Unchanged at 0%
- ECB to Reinvest Maturing PEPP Bonds at Least Through End-2023
- PEPP to Run Significantly Faster Than at Start of Year
- Committed to Persistently Accommodative Monetary Policy
Where there was a surprise, was in the ECB's new language discussing the forward guidance emerging from its new strategic review and inflation policy, where the bank said that "in support of its symmetric two per cent inflation target and in line with its monetary policy strategy, the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term. This may also imply a transitory period in which inflation is moderately above target."
As Bloomberg reminds us, the strategy review changed the ECB’s target to “2% inflation over the medium term” from “close to but below 2%.” So the big question was: How will it change its guidance on when rates change? Here’s a reminder of the old guidance:
“The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.”
And here is the redline comparison on its forward guidance:
In other words, similar to the Fed, the ECB policy will focus on the rearview mirror, tying rate moves to actual interest rate changes rather than forecasts.
The bottom line is that while the statement was tweaked largely as expected, it provided no updated guidance on future PEPP purchases, which according to some was disappointing to the doves.
- The ECB statement notes rates were left unchanged, while forward guidance on rates was tweaked to reflect the new inflation mandatate, with an emphasis on realised inflation outcomes.
- However, no further details were unveiled about a transition for PEPP purchases into a new format, as hinted by President Lagarde; forward guidance on asset purchases was maintained for PEPP and APP.
- Accordingly, there has been some positive ticks in the EUR/USD currency, with analysts reasoning that given that market was looking for a dovish change to the statement, what we have gotten is slightly disappointing (less dovish than expected).
In kneejerk response, and confirming that most of what the ECB said had been priced in, the EUR spiked initially only to fade all gains and to last trade at 1.790, just 5 pips from its pre-ECB level.