The ECB calls time on quantitative easing
- As expected the ECB has raised the refinancing rate by 25bp to 1.25%
- The ‘corridor’ is left unchanged as the deposit and the marginal lending facilities have also been raised by 25bp
- Monetary policy tightening will probably follow
- We expect the refinancing rate to reach 2% at the end of the year
As expected, the ECB Governing Council has decided to raise its official rate by 25bp to 1.25%. Beyond the decision which had largely been priced in, markets focused their attention on two specific points at today’s press conference. Firstly, would the ECB normalise its ‘corridor’ to 200bp and, secondly, on what the monetary policy course for the rest of the year would be.
On the first point, the Governing Council has decided to stay cautious. Since October 2008, the ‘corridor’ (the difference between the marginal lending facility and the deposit facility) has been reduced from 200bp to 100bp, it currently stands at 150bp. A full normalisation of monetary instruments would imply a return to 200bp, but at today’s meeting the governing body decided that it was still too early to widen the band. The decision was essentially to keep the deposit facility at 0.25% as the marginal lending facility is currently not in use as all the liquidity is supplied through full allotment at the refinancing rate.
The ECB will find justifications for further rates increases
On the second point, although Jean-Claude Trichet asserted that the Governing Council had not decided that this was a first step in a tightening cycle, we continue to expect a succession of 25bp hikes. The rationale being the following: as today’s move was dictated by conditions in the euro area as a whole and weakness of the periphery was disregarded, a 25bp increase will not fundamentally change the conditions of the euro area economy on average. Short-term real interest rates are still significantly negative, liquidity is ample, while Germany continues to show signs of sustained activity and most of the euro area is on the road to recovery. According to this logic, the ECB will not be at ease until the official rate is substantially higher. The play is certainly a tricky one, as public accounts are far from sound, the banking system is still fragile and systemic risk remains high. This is why the ECB will probably normalise at a steady pace (we expect 25bp each quarter). This last point seems to be confirmed by the fact that the term ‘strong vigilance’ was removed from the opening statement, suggesting that the ECB does not envisage raising interest rates next month.
The ECB is likely to pause for breath after a few moves, in order to assess the impact of the first stage of the normalisation process. But things seem clear, unless a new round of acute tension begins in the euro area, the ECB is likely to bring its official rate close to 2% before the end of the year.
The message to governments
In terms of the impact on the periphery, this first move will certainly not help but neither will it fundamentally change their situation. Today’s ECB decision is probably also politically motivated. This is a signal intended to show that ample liquidity and non-standard measures will not be around forever and that governments have to do their part of the job.