Curmi & Partners

A Patient, Persistent and Prudent ECB

By Matthias Busuttil

“Monetary policy will remain patient, persistent and prudent”. Those were the concluding words of the European Central Bank (ECB) President Mario Draghi’s speech at “The ECB and Its Watchers” 19th annual conference held last Wednesday in Frankfurt.

The ultra-accommodative monetary policy stance adopted by the ECB in reaction to the sovereign debt crisis in 2011-2012 is still in force today via three main mechanisms. The first is the net asset purchases that are being conducted by the euro area central banks, collectively referred to as quantitative easing (QE). Since the launch of the programme in 2015, where the envisaged expansion of the ECB’s balance sheet was initially estimated to be slightly less than EUR 2 trillion, the monthly asset purchases have been adjusted both in terms of size and extensions in reaction to the previaling economic and monetary conditions in the euro area. The pace of monthly purchases has been reduced to EUR 30 billion in January and the programme is expected to run at least until the end of September reaching an aggregate size of circa EUR 2.5 trillion.

The second mechanism is the commitment to reinvest the principal amounts of the stock of outstanding bonds bought under QE as they mature. This allows the ECB to remain active in the market and maintain stability in the current financing and liquidity conditions.

The third mechanism is the forward guidance on the future path of key policy rates. The ECB’s deposit facility rate for balances placed in excess of required reserves has been at the current level of -0.40% since March 2016. During the last monetary policy meeting on 8th March, the ECB has reiterated its position to keep policy rates at present levels “well past the horizon of ... net asset purchases”.

While the European economy has been improving at a faster pace than expected over the last few quarters and is expected to continue growing at a stronger pace, European central bankers are still awaiting to see convincing signs of a sustained adjustment in the path of inflation to fully withdraw their easing interventions from the market.

The ECB staff projections at the March Governing Council meeting have revised euro area real GDP growth for 2018 upwards to 2.4% from 2.3% projected in December and 1.8% projected in September. Projections for 2017 real GDP growth have also been revised substantially upwards between September and December from 1.5% to 2.4%.

While the economic growth momentum is substantiated further by improvements in the labour market, private consumption, financing conditions, business investment and corporate profitability, euro area HICP inflation has decreased gradually from the highest point in 2017 of 1.5% down to 1.2% estimated for February 2018. ECB staff projections for euro area inflation are 1.4% in 2018 and 2019 and 1.7% in 2020.

The central bank is eyeing three main ingredients that produce a sustained adjustment in the path of inflation towards their target level of close to but below 2%; convergence, confidence and resilience. Convergence means that the trajectory of projected inflation has to be on a path moving towards the targeted level over the medium term. Confidence refers to the increase in the likelihood that the projections are achieved, i.e. a reduction in downside risks. Lastly, resilience refers to the requirement that the path of adjustment in inflation has to be self-sustaining and independant of the QE programme.

When assessing the outlook on changes in monetary policy, the relative prominence of each of the three main policy mechanisms is gradually evolving.

As we now approach the September QE deadline, the market is expecting a final extension of a further EUR 30 billion in total net purchases to be conducted throughout Q4. The focus now will start to shift on the potential factors that determine the ECB’s forward guidance policy.

Market participants are citing March 2019 as a possible target date for the first rate hike. However, in my opinion, that is probably too optimistic when considering that the QE programme is only likely to be completely stopped in December. Moreover, the ECB has been focusing on increasing its predictability in an attempt to avoid inducing volatile market reactions. Therefore, it would probably allow itself more time to communicate its intentions to the market prior to announcing official changes in policy rates.

Once more clarity is achieved on the ECB’s assessment of its forward guidance policy, the focus will shift on the modalities of the principle reinvestments and possible changes or reduction in the rate of reinvestment.


The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.