Draghi’s time horizon for rates seen to exceed a year

Market Reaction

The euro slid against the dollar, while bonds and stocks rose after Draghi’s statement, which coincided with a rate outlook by the Bank of England after Mark Carney’s inaugural meeting as governor.

The “message, it seems, was understood by the market,” ECB Governing Council member Erkki Liikanen said on July 5.

The euro-area economy is struggling to emerge from the longest recession since the introduction of the single currency in 1999. Economists in the Bloomberg News survey predict the euro-area economy stagnated in the second quarter.

Gross domestic product will rise 0.1% in the three months through September and 0.2% in the subsequent two quarters, according to the median result in the survey. At the same time, unemployment is forecast to rise to a record 12.4% later this year.

‘Radical Change’

In pledging to keep rates low, the ECB departed from a tradition of never “pre-committing” to any future monetary policy. While the ECB’s version of forward guidance differs from that of other central banks, which have tied interest-rate moves to particular economic indicators or a timeframe, it signifies a “huge, radical change” in European central banking, said Frederik Ducrozet, an economist at Credit Agricole CIB in Paris.

“It’s not just a near-term communication trick, and Draghi once again proved that he isn’t helpless,” Ducrozet said. “But it’s a bit of a risky move because he could be pushed by markets for more clarity, clarity they might be unable or unwilling to provide.”

The majority of economists surveyed doesn’t expect the ECB to develop its commitment at all, while 10 of the 50 participants predict policy makers could evolve last week’s pledge with specific targets. Five forecast the addition of a time period.

‘Quite Vague’

The ECB statement was “quite vague” and “this likely hasn’t been without reason,” said Duncan De Vries, an economist at NIBC Bank NV in The Hague. “Policy makers will probably prefer to keep the interest-rate pledge as vague as possible.”

Forward guidance doesn’t mean that interest rates can’t be raised in the future if inflation picks up, ECB Governing Council member Jens Weidmann said in a speech in Munich today.

The pledge doesn’t present a “shift in strategy,” he said. “It’s an attempt to explain our monetary stance in an easier, more comprehensible way so that it is understood by preferably all market participants.”

Eventually, the ECB will have to deliver on its “vague promises,” former board member Lorenzo Bini Smaghi wrote in a guest commentary today for German newspaper Handelsblatt. He predicted that “concrete steps” will be needed in the next months, which may include another rate cut, a negative deposit rate or new longer-term refinancing operations.

For Carsten Brzeski, senior economist at ING Groep NV in Brussels, “a lot will depend on the Fed.”

“If Fed tapering starts toward the end of the year and U.S. yields continue to increase, the euro-zone periphery will suffer from increasing peripheral bond yields,” he said. In that case, “the ECB might be forced to increase its forward guidance by more specific targets.”

Draghi will repeat the phrase in his decision statements for at least six months, according to 38 of 43 economists in the survey. Of those, 15 respondents predict the commitment will remain part of his monthly remarks for more than a year.


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