What The ECB's "Unprecedented" Forward Guidance Means

Confused what the (non) news of today's "unprecedented" forward guidance announcement by the ECB means? Shocked that the ECB is about as dovish as it has ever been, after having missed the following chart showing the record low European bank lending to the private sector which predicted all of today's action (Stolper's long EURUSD reco fade notwithstanding)...

Then SocGen is here to explain, if only for all those who are seemingly stunned that the ECB isn't planning on hiking rates, or even "tapering" any time soon.

"Forward Guidance" Introduced, from SocGen

The ECB came out with all dovish guns blazing today to reverse the tightening in money and financial market conditions since June, stoking a rally in euribor futures (lower rates) but causing the EUR to drop nearly 1% vs the USD. The only thing that was missing today was a cut in the refi rate and/or negative deposit rate, but neither has not been ruled out given that downside growth risks continue to exist. Casting better macro data side, the ECB officially introduced ‘forward guidance' on rates and said exit is “very distant”.

The introduction of ‘forward guidance' characterises the fact that all key ECB rates will stay low for a longer period. This makes the ECB fall in line with the guidance by the US FOMC on the Fed funds target, the Bank of Canada and most probably, the BoE in August. Put on the spot during the press conference, president Draghi rejected claims the ECB had come off the proverbial fence in response to a changed outlook for US monetary policy given the spill over effect from a steeper US yield curve across the Atlantic and the steepening impact on eurozone core and periphery debt markets. Taking after the BoE earlier (a coincidence, Draghi said), the ECB is worried that the tightening in financial conditions will handicap the prospects for economic recovery in the euro area where the credit growth remains very weak and fragmented.

The move clearly marks an innovative step in the ECB's communication and policy strategy for a bank that previously had always refused to pre-commit on interest rates. Draghi did not commit explicitly how long rates would stay low but hinted that there would be no change for at least 12 months (“extended period is not 6 or 12 months”). The decision to introduce forward guidance was unanimous and how long this bias will be observed will depend on the assessment of three variables ie inflation, growth and monetary developments (credit flows, monetary aggregates). The case for a cut in the refi rate was also discussed but there was no agreement.

The retention of ammunition should the economy move back into reverse was important to the ECB and this probably explains why there was no consensus to cut the refit rate from 0.50%. Draghi categorically said that 0.50% is not the “lower bound” for rates. This implies that further stimulus is still possible. For EUR/USD, key support now rests at 1.2877 before selling towards the April 1.2746 low is stepped up.