The central bank for the 19 European nations that use the single currency left its key interest rates and asset purchase program unchanged but said it will soon decide on the extent of its extensive stimulus program for next year, fueling speculation it will join the U.S and Canadian central banks in slowly and methodically unwinding the ultra-easy monetary policies adopted in the wake of the global financial crises.
The European Central Bank (ECB), which has kept its benchmark refinancing rate at zero percent and the deposit rate at minus 0.40 percent since March 2016, raised its forecast for economic growth but lowered its inflation forecast due to a higher exchange rate of the euro.
But ECB President Mario Draghi also cautioned that the euro area is in need of “a continued very substantial degree of monetary accommodation to secure a sustained return of inflation” that is close to the target of below, but close to 2.0 percent.
Draghi also confirmed the ECB’s asset purchases, aimed at keeping down long-term interest rates, would continue at their current monthly pace of 60 billion euros until December, and reiterated the guidance – first issued in 2013 – that he expects key ECB rates to remain at their present level for an extended period of time, and well past the horizon of asset purchases.
But while Draghi voiced confidence the ongoing economic expansion will gradually pull up inflation towards the target of just below 2.0 percent, the strength of the euro may now delay this. A strong exchange rate tends to hold down import prices and thus inflation.
“The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability,” Draghi said.
The euro has been strengthening all year after hitting a record low of US$1.04 in December 2016 as investors grew convinced the euro area’s economy finally was recovering.
In June the euro got another boost when Draghi in Portugal said “the threat of deflation is gone and reflationary forces are at play,” fueling speculation of “quantitative tightening” with the ECB at first scaling back its monthly asset purchases before joining the U.S. and Canada in raising rates.
Today the euro then jumped to over $1.20, a level not seen since January 2015, as Draghi said the ECB governing council would decide on “the calibration of our policy instruments beyond the end of the year,” raising the prospect that its massive stimulus program will be wound up.
The next monetary policy meeting of the governing council is Oct. 26.
Draghi said the ECB’s new economic projections, which will be released in two weeks, showed that economic growth remains broad-based, with private consumption supported by higher employment and household wealth while investment is benefiting from easy financing and improved corporate profitability.
Annual growth in the euro area this year is now forecast to rise to 2.2 percent this year, up from the June forecast of 1.9 percent.
In the second quarter of this year euro area Gross Domestic Product expanded by 2.3 percent year-on-year, up from 2.0 percent.
But next year and in 2019 the economy is seen slowing to growth of 1.8 percent and 1.7 percent growth, respectively, unchanged from June.
“Risks surrounding the euro area growth outlook remain broadly balanced,” Draghi said, with the current positive cyclical momentum raising the chances of higher growth while foreign exchange markets pose downside risks.
Headline inflation in the euro area has come down from levels around the ECB’s target earlier this year and Draghi expects a further temporary decline towards the end of this year due to the base effect of energy prices.
And while underlying inflation has ticked up, Draghi said it has yet to show convincing signs of a sustained upward trend and cost pressures from labour markets remain subdued.
ECB staff forecast headline inflation of 1.5 percent this year, unchanged from the June forecast, then 1.2 percent in 2018, down from 1.3 percent. In 2015 inflation is seen at 1.5 percent.
A flash estimate shows euro area inflation of 1.5 percent in August, up from 1.3 percent in July.
The European Central Bank issued the following statement:
“At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.