Thursday, May 8, 2014

The ECB focusing on downside risks

The ECB struck a dovish tone this morning, with Draghi hinting that the Governing Council is prepared to take action.
BBC: - He said that the 24-member ECB council was "dissatisfied about the projected path of inflation" and is "not resigned to have too low inflation for too long a time".

... he added that the ECB was "comfortable with acting next time", raising expectations that the bank could alter policy in June.
Eurozone bonds rallied in response, with periphery yields hitting new lows.
10y Spanish government bond yield (source:

The ECB is becoming inpatient with the so-called "creditless" recovery (see post), as pressure mounts on the central bank to take action. This is exacerbated by external factors such as China's slowdown and the situation in Ukraine.
Draghi: - ... although labor markets have stabilized and shown the first signs of improvement, unemployment remains high in the euro area and, overall, unutilized capacity continues to be sizable. Moreover, the annual rate of change of MFI loans to the private sector remained negative in March and the necessary balance sheet adjustments in the public and private sectors continue to weigh on the pace of the economic recovery.

The risks surrounding the economic outlook for the euro area continue to be on the downside. Geopolitical risks, as well as developments in global financial markets and emerging market economies, may have the potential to affect economic conditions negatively. Other downside risks include weaker than expected domestic demand and insufficient implementation of structural reforms in euro area countries, as well as weaker export growth.
However it remains unclear what options the ECB really has. A traditional bond buying program could be difficult, given the unease in the Eurozone core with the central bank taking on more periphery credit risk. And a program focused on ABS and other consumer and corporate credit products will be limited in scope (see post).
GS: - ... in line with Mr. Draghi’s recent signals to German parliamentarians, a large-scale asset purchase programme Fed-style remains unlikely in our view (around 15% probability for such measures through year-end). However, the likelihood of some targeted asset purchases in specific financial market segments is higher (we attach a 25% probability).
The ECB is hoping that this dovish language by itself will ease monetary conditions. It has worked so far by lowering bond yields and capping euro's appreciation. But with the Eurosystem's balance sheet continuing to decline (draining liquidity), will talk be enough?

Eurosystem consolidated balance sheet (source: ECB)

See the full video of Draghi's speech below:
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