The ECB has dramatically changed its monetary policy. The Asset Purchase Programme (APP) will stop next December. The amount that will be bought by the ECB will be halved after September to EUR 15bn.
The ECB will continue to invest the proceeds of its portfolio. It will guarantee the liquidity of the market and maintaining rates at a low level.
The ECB said that rates will not increase before the end of summer 2019.
The ECB remains confident in the business cycle meaning that the current weaker phase is perceived as transitory. The central bank has a lower growth forecast for 2018 (compared with March) at 2.1% but unchanged for 2019 and 2020.
The forecasts are higher than in March in 2018 and 2019 at 1.7% but unchanged for 2020 at 1.7% still way below the ECB target
The reason for ending the APP is the robustness of the business cycle and a risk of deflation which is now negligible. So there is no needs for a very accommodative monetary policy stance.
On a technical basis, it would have been hard for the ECB to purchase German bunds.
The ECB takes time to normalized as it doesn’t want to create a negative shock on expectations that could hurt the Euro Area growth profile. It’s the usual central banks’ mantra.
Beyond these questions, there is a real issue now for the euro area which it’s capacity to react in case of an economic downturn.
The current policy mix is neutral on the fiscal side but still very accommodative on the monetary side. What would be the economic policy reaction in case of a growth downturn? We can’t expect a strong fiscal policy as Germany will not accept it. That was the sense of her recent interview with the German newspaper FAZ. Therefore the only source of positive impulse could come from the ECB. But the current level of interest rate is too low for that.
In other words, the ECB is in the position the Fed had when it started its normalization process (2014) considering that it has time and leeway before a negative shock. That’s how we have to understand the ECB move on the top of reasons I mentioned above.
The main risk is a rapid negative shock that could come from a US recession resulting from the current Fed’s monetary policy. I have explained elsewhere that the current US policy mix was not sustainable and that the Fed has to tighten its stance in order to counterbalance the strong fiscal policy. This will lead to a flat yield curve creating a high risk of recession in the US in 2020. If the ECB starts it’s rate normalization at the end of 2019 what would it’s capability to fight a downturn in economic activity. Still an open question.