ECB policy measures bearing fruit

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As was widely expected, the ECB kept policy on hold in its April meeting. According to Mr. Draghi its March stimulus package had led to an improvement of broad financing conditions in the euro area. Nevertheless, the central bank kept the door open to ease policy further if necessary, saying the risks to the eurozone growth outlook still remain tilted to the downside. The Governing Council will “continue to monitor closely the outlook for price stability and, if warranted to achieve its objective, will act by using all the instruments available within its mandate”, according to Mr. Draghi.

The ECB will probably need to do more as inflation is still set to undershoot its target for a long time. Aline Schuiling thumbnail Aline Schuiling Senior Economist

  • The ECB kept policy on hold ...

  • ... while signalling that the door is still open for further policy easing

  • Meanwhile both the ECB’s Bank Lending Survey and its Survey of Professional Forecasters suggest that its past policy measures are bearing fruit

  • April business surveys suggest the eurozone economy will stay on a path of ongoing moderate recovery

We think the ECB will probably need to do more as inflation is still set to undershoot its target for a long time and the recent easing of domestic financial conditions will likely not be sufficient to change this picture, especially since the euro has risen. We expect further policy easing will come in the second half of the year (likely in September), as two of the main measures the ECB announced in March (the TLTRO II and the corporate sector purchase programme) will not even be implemented until June. We think that eventual further easing will take the form of a step up and extension of QE. Although we think further modest deposit rate cuts are possible, this step may only be taken if there is a significant uptrend in the euro. We think the ECB will probably need to do more as inflation is still set to undershoot its target for a long time and the recent easing of domestic financial conditions will likely not be sufficient to change this picture, especially since the euro has risen. We expect further policy easing will come in the second half of the year (likely in September), as two of the main measures the ECB announced in March (the TLTRO II and the corporate sector purchase programme) will not even be implemented until June. We think that eventual further easing will take the form of a step up and extension of QE. Although we think further modest deposit rate cuts are possible, this step may only be taken if there is a significant uptrend in the euro. 

ECB Bank Lending Survey shows that credit standards continue to ease …

The ECB’ Bank Lending Survey (BLS) for Q1 showed that banks, on balance, continued to ease credit standards for loans to non-financial companies. Credit  standards eased at an accelerated pace (-4% in 2015Q4 to -6% in 2016Q1).

… supported by the ECB’s QE policy

In a special ad hoc questionnaire, banks reported that the ECB’s QE programme had had a net easing impact on the credit standards for loans to enterprises of 3%. It seems that ECB policy measures compensated part of the tightening impact on credit standards of the turmoil in financial markets, the sell-off in bank equities and deterioration in the economic climate in the first two months of this year. Negative interest rates were seen as having widely hurt bank profits, but had also contributed to lower bank lending rates and somewhat higher bank loan volumes.

Demand for loans still positive, but weaker than in 2015Q4

Net demand for loans to enterprises continued to rise in Q1, but less sharply than in 2015Q4. It fell to +17%, down from +27% in Q4. Loan demand tends to move closely in line with business climate indicators such as the manufacturing PMI and the Ifo business expectations. Therefore, the slowdown in the growth in demand for loans seems to reflect the deterioration in the business climate in the first few months of this year. Banks report that the main contributing factors for loan demand were inventories and working capital, the level of interest rates and M&A activity. The contribution of fixed investment remained positive, but was small compared to the other factors in Q1, while it also declined from the level in 2014Q4. This suggests that fixed investment growth declined in the first quarter of this year after it grew robustly in 2015Q4. 

20160425-Eurozone loans to non-financial companies

20160425-Inflation forecasts SPF

Confidence in the ECB meeting its policy target is rising

The ECB’s Survey of Professional Forecasters (SPF) for 2016Q2 was also published this week. It revealed that confidence in the ECB meeting its inflation target in the medium term has risen somewhat. Whereas the forecast for the inflation rate five years ahead remained unchanged at 1.8%, the probability attached to the ECB meeting its target rose. The participants to the SPF attached a probability of 53% to inflation being in a narrow range around 2% five years from now. The probability of inflation below this target declined from 37% in Q1 to 34% in Q2, while that of inflation being higher than the target increased from 12% to 14%. The fact that a higher probability was attached to the ECB meeting its target for inflation in the medium term was probably due to the extra policy easing measures announce by the central bank in March.

Surveys point at ongoing moderate economic recovery

Meanwhile, surveys published during the week signaled that the eurozone economy has remained on a path of ongoing modest economic growth. Germany’s ZEW economic sentiment staged its second consecutive monthly rise in April but remained well below its long-term average value of 25 and also below its value at the end of 2015. Therefore, it seems consistent with moderate economic growth in Germany. Indeed, we think that a number of one-off factors temporarily lifted GDP growth in Q1, but that it slowed down again in Q2. The eurozone economy as a whole will probably show a similar growth pattern in the first half of this year. The composite PMI fell slightly in April, to 53.0, down from 53.1 in March. The manufacturing output index declined, while the services sector PMI increased slightly. 

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