ECB keeps monetary policy on hold, decision on changes to policy likely to be made in October

As widely expected, the European Central Bank kept its monetary policy on hold during its meeting today, leaving interest rate on its refinancing operations, marginal lending facility, and its deposit facility on hold at 0 percent, 0.25 percent and -0.40 percent, respectively. Monthly asset purchases of EUR 60 billion would continue at least until the end of 2017, depending on the evolution of the outlook for inflation and progress made toward the 2 percent target, noted TD Economics in a research report.

In the press conference, President Mario Draghi mentioned that the bulk of decisions on changes to the ECB’s monetary policy, especially its asset purchase program, would possibly be made during the 26 October meeting. Furthermore, the ECB governing council discussed different scenarios about changes to its current monetary policy, including the trade-offs between the scenarios, their length and size, and related pros and cons, stated TD Economics.

New ECB Staff macroeconomic projections indicate an upward revision to economic growth for this year; however, the growth outlook for 2018-2019 continues to be the same at 1.8 percent and 1.7 percent, respectively. The central bank downwardly revised its headline HICP inflation for next year, mainly due to exchange rate pass-through from euro appreciation. Meanwhile, the HICP inflation projection for 2018 was downwardly revised by 0.1 percentage point to 1.5 percent. Trend inflation measures were also downwardly revised by 0.1 percentage point to 1.3 percent for next year, and downwardly revised by 0.2 percentage points to 1.5 percent for 2019.

The ECB upwardly revised its estimates on labor productivity growth for this year, and widely unchanged thereafter relative to the June projection. This might suggest that trend labor productivity growth, and therefore potential output growth, in the euro area might have been running slightly stronger than estimated earlier since the euro area recovery started in 2014.

The reaction from market was mixed. The EUR/USD pair rose sharply above 1.20 after the press conference started. In the meantime, euro area bonds were heavily bid. But, after the press conference ended the EUR/USD dropped below 1.20.

The euro area economy has been growing strongly, with growth averaging around 2.3 percent in the past three quarters. Job growth has been robust, while the breadth of the rebound throughout nations and industries has been impressive. This is greatly why the ECB is contemplating the removal of some monetary accommodation, which is likely to begin with a stable reduction in asset purchases in 2018, said TD Economics.

In spite of the rosy growth outlook, the lack of a sustainable rise in inflation will guarantee a very gradual removal of monetary accommodation by the ECB. The quick strengthening of the euro in recent months gives additional headwinds on the inflation front, as seen by downward revisions to the inflation outlook today. However, the ECB continues to be convinced that given the outlook for solid economic and employment growth it is just a matter of time before inflation converges to its 2 percent target.

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