By William Watts
The European Central Bank on Thursday tweaked and simplified its policy message after changing its inflation target. The key takeaway — interest rates are going to remain low for a long time.
The ECB earlier this month completed a strategic review, adopting a symmetric 2% inflation target in place of its previous aim of keeping inflation near but just below 2%. That left investors waiting to see how the ECB would alter its so-called forward guidance on rates and policy to match up with the new framework.
In its Thursday statement, the Governing Council said it wouldn’t increase interest rates — including its key rate that stands at -0.5% — until it sees inflation near its 2% target and it appears likely to remain there. The ECB said this “may also imply a transitory period in which inflation is moderately above target.”
“We expect the ECB to maintain its status quo of ‘status low’ for the foreseeable future, with rate hikes unlikely to be on the policy agenda until the second half of this decade at the earliest,” said Gurpreet Gill, macro strategist for global fixed income, at Goldman Sachs Asset Management.
Investors had been looking for a dovish, or less inflation-averse, statement from the ECB, but the guidance may have gone “a bit further than expected,” said Franziska Palmas, markets economist, at Capital Economics.
That said, it didn’t likely didn’t do much to move the needle for European bond yields, she said. After all, the ECB didn’t indicate it saw any need to loosen policy, and it wasn’t clear policy makers would have been likely to raise rates over the next few years if it had stuck to its previous guidance.
She said that may explain why yields on 10-year government bonds in Germany /zigman2/quotes/211347116/realtime BX:TMBMKDE-30Y 0.00% , France /zigman2/quotes/211347162/realtime BX:TMBMKFR-10Y 0.00% , Italy /zigman2/quotes/211347230/realtime BX:TMBMKIT-10Y 0.00% and Spain /zigman2/quotes/211347132/realtime BX:TMBMKES-10Y 0.00% initially rose, than reversed the move, with all trading somewhat lower than seen before the ECB announcement. The yield on the 10-year German government bond, or bund, was off 3.7 basis points at 0.427%.
Besides, bond yields, which move in the opposite direction of prices, had already retreated significantly in the weeks ahead of the meeting, analysts noted.
The euro /zigman2/quotes/210561242/realtime/sampled EURUSD -0.0768% initially softened in response to the shift, but trimmed its decline after an unexpected rise in first-time U.S. jobless claims undercut the U.S. dollar. The euro was off 0.3% at $1.1759 in recent action. The ECB’s move stands in contrast to the U.S. Federal Reserve, which is seen moving toward pulling back monetary stimulus.
ECB President Christine Lagarde, in a news conference, pushed back against the idea that the guidance indicated rates would remain “lower for longer,” saying it was instead intended to prevent a premature policy tightening. But economists said the guidance coupled with current ECB projections suggests rates are unlikely to budge for years.
With the ECB looking for inflation to come in at just 1.5% at the end of its current forecast horizon in 2023, the criteria for a hike “will almost certainly not be met before 2024 and perhaps not even 2025,” when the ECB is due to hold another strategic policy review, wrote economists at Daiwa, in a note.
What about the ECB’s asset purchases?
Lagarde said policy makers didn’t discuss changes to its 1.85 trillion euro ($2.2 trillion) pandemic emergency purchase program, or PEPP, under which it has been buying around 80 billion euros a month worth of eurozone debt. The program is due to expire in March.
Noting that Lagarde called any discussion about exiting the PEPP premature, the likelihood of a tapering announcement in September appears to have “meaningfully declined,” said Marco Valli, chief European economist at UniCredit, in a note.
The fast spread of the delta variant of the coronavirus that causes COVID-19 is “certainly playing a role,” Valli said. With the ECB able to keep buying bonds at the current pace until March without having to increase the PEPP envelope, “it is difficult to see why the GC would want to be seen engaging in concrete exit talks already in the next few weeks,” he said.