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ECB Cuts Rates, Commits to Open-Ended Quantitative Easing

Karl Schamotta September 12, 2019

The European Central Bank has cut rates and launched a new round of monetary stimulus in a desperate bid to lift growth and pull the euro area economy out of a disinflationary spiral. The move comes after central banks from the United States to Indonesia slashed rates – and only nine months after Mr. Draghi brought the ECB’s last stimulus effort to an end.

In a closely-watched decision, the 25-member Governing Council lowered its benchmark lending rate to -0.5% from -0.4%, and committed to keeping rates at “present or lower levels” until the inflation outlook rises toward its 2% target.

Asset purchases are set to commence in November and will be conducted at a pace of 20 billion euros a month – running for “as long as necessary” and only ending “shortly” before interest rates begin to rise once again. This means that bond-buying may continue for years – and that the Bank could soon test the 33% threshold for purchases from any single government.

The Bank also announced a long-expected “tiering” plan, which will exempt banks from paying negative rates on some of their deposits. Two interest rate tiers will be introduced, with additional details to come on the size and methodology applied.

Updated projections show that the ECB expects euro area growth to hit 1.1% for full-year 2019 – 0.1% weaker than forecast in June. Expectations for next year were adjusted more materially, to 1.2% from 1.4% previously.

Inflation is now expected to track at 1.2% in 2019, 1% in 2020, and 1.5% in 2021.

The euro dropped and bond yields rose slightly in the announcement’s aftermath – and this reaction was exacerbated when the Bureau of Labor Statistics reported the biggest jump in US core inflation seen in more than a decade.

The core consumer price index rose 0.3% in August, up 2.4% over a year earlier – suggesting that inflationary forces were growing before President Trump’s latest tariff announcements.

A separate report showed claims for unemployment claims falling last week, suggesting that the labor market also remains strong.

These data are unlikely to lower expectations for a second consecutive cut when the Federal Reserve meets next week, but could lend credence to hawkish views on the rate-setting committee – keeping interest rate differentials tilted in the dollar’s favor for now.

Bottom Line: In his second-to-last meeting as ECB President, Mario Draghi largely delivered against market expectations, essentially committing to doing “whatever it takes” to raise inflation in the euro area. The announced asset purchases may be smaller and rate cuts slightly weaker than some had hoped, but the open-ended and inflation-pegged nature of the new stimulus program will help anchor expectations over the long term.

Of course, that comes with a big caveat – markets simply don’t believe the central bank can materially change economic outcomes on its own. Governments will have to step in. As Mr. Draghi put it during the press conference, “there was unanimity that fiscal policy should be the main tool” used to boost inflation and growth rates.

And now over to you, Mrs. Merkel…

Karl Schamotta
Chief Market Strategist

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