Friday, November 20, 2015

ECB minutes: Deflation risks persists; more stimulus likely in December

FXStreet (Mumbai) - The minutes of the European Central Bank’s Governing Council’s October meeting was published yesterday. The accounts of the meeting mentioned weak regional and global growth. The minutes showed that the ECB officials were concerned that their stimulus measures have not been successful enough to put European recovery on track. The weak inflation data likely prompted officials to signal that further monetary easing is needed to keep inflation from staying too low for too long. Resistance showed by the US Fed in raising rates have also forced the ECB to act sooner. The accounts mentioned that there exists a strong case for injecting more stimulus into the euro zone’s economy.

Governing Council accepted the need to have a re-look at the degree of monetary policy accommodation at its Dec. 3 meeting.

Deflation likely to continue to plague European recovery

The Council has highlighted the concern over slow euro recovery that is challenged by risks of deflation. In the minutes there was reference of the deflationary scenario which the Council admitted “could not be fully excluded as a tail risk”. Lower oil prices were held responsible for the persistent weak prices. The central bank however noted that the likelihood of deflation had decreased since the start of the year.

The ECB has warned that inflation after picking up slightly towards the end of the year on oil-price related base effects “could fall back to relatively low levels in early 2016”. On the face of lower energy prices as and recent exchange-rate developments, a further downward revision to the inflation outlook is possible. A downward revision to the inflation outlook will lead to the postponement of the return of inflation to levels set by the ECB.

It is true that the aggressive monetary easing is gradually helping to ease the region’s credit markets and boosting lending. There however remains a dominant fear in the market that the inflation will take much longer to return to target than officials had hoped when the QE was first launched. Some members are particularly worried by weak demand that has further pushed down core inflation rates. Core inflation currently is 1.1 per cent. At the moment, annual headline inflation is 0.1 per cent in the bloc, a rate similar to that of other advanced economies. It must be however be noted that the price pressures in the euro zone have been weaker for a longer time compared to other economies.

The ECB likely to opt for more monetary easing in December

The ECB can be expected to initiate an enhanced version of its €1.1tn quantitative easing package in December. The ECB could increase its monthly purchases under QE from the current level of euro 60 billion or buy other assets. The council can also opt to extend purchases beyond the current deadline of September 2016.

Also, the central bank is likely to cut one of its benchmark interest rates deeper into negative territory in its early December vote. The council also expressed its willingness to abandon an earlier commitment to keep interest rates unchanged as well as increase the rate it charges on a portion of reserves held at the euro zone’s central banks from the current 0.2 per cent. Some of the council members have argued “that a rate cut would venture further into uncharted territory and have repercussions on the functioning of markets and the behaviour of banks and customers”.

The Council opted to wait till December to unleash the new phase of easing as the bloc’s economy have so far proven resilient to weaker global growth.
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