The ECB acted more aggressively than was expected at its most recent policy meeting. In our Global Daily Insight and our ECB Watch of 6 June we detail and explain the measures that were taken. Here I will try to assess the measures. I am inclined to consider them largely pre-emptive. The direct impact will be very hard to establish, the effects will have to materialise over time. On the other hand, the one area of direct impact is confidence. If you engage a 'shock and awe' strategy, boosting confidence is obviously one of your aims. Looking at financial markets, one must say that ECB President Mario Draghi has been very successful.
When I look at the economic data, I see an overwhelming amount of evidence that economic conditions are improving.
Han de Jong Chief Economist
Why did they do it?
The ECB acted aggressively in order to prevent deflation taking hold and to oil the credit mechanism. One can ask how necessary that really was. Inflation is clearly below the ECB's target, but we are not in deflation. However, the ECB wants to prevent deflation and they do not want to get into a situation where they have to fight actual deflation. In that sense, one can say that the ECB's action was somewhat pre-emptive, though if inflation is as much below target as it currently is, policy action is certainly justified. The ECB lowered its growth forecast for this year a little and raised it a little for 2015. It seems to me that the revisions were largely backward looking in the sense that 2014 Q1 GDP data was a little weaker than expected. It seems to me that the actual view on economic progress in the quarters ahead has not changed much. When I look at the economic data, I see an overwhelming amount of evidence that economic conditions are improving. Admitted, from a low base in many cases and the recovery is not particularly strong, but it should at least be enough to start unemployment falling. As that trend spreads, the downward pressure on wages will ease and thereby the most important potential cause for painful deflation.
The most recent data on German industrial orders paint an interesting picture. These orders were up handsomely in April, 3.1% mom. We must bear in mind that orders had fallen 2.8% in March so there is a lot of volatility, probably caused by the timing of Easter. Nevertheless, the actual orders data beat expectations by a wide margin. Orders from other eurozone countries were particularly strong: +9.9% mom. What I find especially encouraging is that orders for capital goods from other eurozone countries is growing rapidly. They increased by 11.7% mom. I must admit that the series is erratic. For the first four months of the year, capital goods orders from other eurozone countries placed with German companies were up 5.6% yoy. That suggests that European companies have started to increase capital spending. That is a good sign and, if sustained, it is not a typical trend for an economy likely to fall into nasty deflation shortly.
The question concerning the credit mechanism is hard to assess. Credit to non-financial corporates has been shrinking for a while. But it is always unclear if that is because banks are not lending or because credit growth is weak. The most recent data on credit actually show a modest improvement. The last bank lending survey of April does not give me much reason to think there is a particularly large problem. Differences between countries are substantial, but it is hard to argue that banks in the periphery are tightening their lending criteria. The last survey included a question on how current lending criteria compare to the averages since 2003 and since 2010. Unsurprisingly, lending criteria are now tighter than the average since 2003, but not tighter than since 2010. Many companies, particularly in the SME sector, complain about reduced access to bank credit. Again, it is hard to gauge this. Many of these companies are experiencing difficult times and risks for bank are relatively high. Then there is also the issue of regulation and supervision. Banks have to improve their capital ratios and are generally forced to follow more tedious administrative procedures. That all has a cost.
Will they be successful?
It seems to me that the ECB is blowing with the wind here. I believe that painful, sustained deflation is unlikely and I think the economic upturn will broaden and strengthen over time. So the eventual results will be in line with what the ECB wants. That is not to say that their recent actions will be decisive. How much impact can you expect from a rate cut by 10 bp? In addition, central banks can create phenomenal amounts of liquidity, but European banks are actually gradually paying back to liquidity support measures (LTROs) made available in 2011 and 2012. That suggests that liquidity is not exactly an important bottleneck.
That leaves me with confidence. If a central bank takes more aggressive action than is expected, they are trying to achieve something. It is called "shock and awe" and the purpose is to boost confidence that everything will be OK in the end. It is early days yet, but the initial market response (equities, credit spreads and sovereign spreads) suggests that at least participants in these financial markets have become more confident.
Will the ECB do more?
The ECB would undoubtedly prefer if they did not have to take further action. In addition, once you have taken aggressive action, you have to sit on your hand for a while. Having said all that, Draghi made it clear that they will act again if necessary. Given our optimistic view on the outlook for the economy, we still consider a 'full-blown' QE programme in which the ECB buys large amounts of sovereign debt is unlikely.