On Thursday afternoon the European Central Bank (ECB) maintained the deposit rate at -0.4 per cent as had been widely expected, while the main refinancing rate was held at zero.
However, it insisted that easing is here to stay.
Mario Draghi’s post announcement comments were aligned to the ECB’s economic data monitoring, which - as opposed to their previous guidance, that of a rebound in quarter 2 and 3 of this year - are now pointing to a more distressed scenario.
Furthermore, the issued statement by the governing council changed its forward guidance to say that it expects rates to remain at their present lows or even at lower levels, at least through the first half of 2020. The said change in language pushed the market towards a rate cut probability in September’s meeting to 83.5 per cent, from the previous sub-50 per cent level.
What is interesting is the re-enforced argument of assuring that price stability is the main aim, and in this regard it stands ready to adjust all of its instruments as appropriate, to ensure that inflation moves towards its target level in a sustained manner. This supports the market perception that easing will possibly kick in if economic expectations continue to deteriorate.
The initial market reaction on the announced statement was positive, which however, reversed following the press conference when Draghi, despite re-instating that all options are being studied, added that their implementation is still tied to economic data.
We are of the view that given the recent slump in data, namely the latest manufacturing data in Germany (79 per cent of total production), the ECB will act in its September’s meeting. That said, the ECB might be well aware that going forward monetary policy might be now returning diminishing returns and thus further stimulus might not be effective as initially thought.
Many view the possibility of fiscal policy as an alternative. The issue going forward is whether, for instance Germany, which is considered as the largest economy, is willing to increase its fiscal spending. In all fairness fiscal spending does not always result in an economic boost and this was witnessed by Germany itself when the latter increased fiscal spending. In reality what happened was that it resulted in an increase in prices with core inflation touching the 1.8 percent levels. Thus the willingness of Germany in adopting a fiscal push might not be an option.
On the contrary, other countries which also are heavily dependent on manufacturing, such as Italy (88 per cent of total production), is willing to increase its spending, but its constrained by its debt ceiling. Thus although Draghi might view fiscal spending as an alternative to the diminishing effectiveness of monetary stimulus, in reality pushing towards fiscal spending might be a difficult task.
Ultimately, we still believe that the ECB will not be the odd one out. As with other central banks which have recently cut rates, namely in emerging markets, prior to the expectations that the Federal Reserve will cut rates next week, the ECB will in its next meeting will have to come up with some sort of easing.
This is why we believe that government bonds might still be faced with further tightening in yields, i.e. price increases.
Next week’s Fed meeting will shed more light on how the ECB might act in its September meeting. In addition, we are very constructive on the view that the incoming new ECB President will continue to push in trying to achieve the desired target inflation figures.
This article was issued by Jordan Portelli, investment manager at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.