Thursday, July 21, 2016

ECB Holds Rates Steady; Leaves Door Open for Stimulus Later This Year

The European Central Bank announced this morning that they were holding rates steady, meeting market and analyst expectations for their July meeting.  The main refinancing rate remains at 0%, the deposit rate is steady at minus 0.4%, the marginal lending facility rate at 0.25% and the ECB held their Quantitative Easing position at a monthly €80 Billion.  None of this came as a surprise to world markets which have thus far stabilized since the surprising Brexit vote in June.

Caution was the order of the day as the Central Bank adopted a "wait and see" attitude, postponing any decisions until their September 8th meeting.  There's growing speculation that an increase in Quantitative Easing could be announced then, however in his post-announcement speech Mario Draghi stated, "We confirm that the monthly asset purchases of 80 billion euros are intended to run until the end of March 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim." 

Haven't we heard that before?  It sounds very similar to the tune sung by the US Federal Open Markets Committee throughout the final year of QE3 here in the States. Essentially, yes they have an end-date, yes there's a fixed amount planned into the process, but oh by the way, that end date will ultimately be data dependent based upon the prospects for normalized inflation, defined both in Europe and in the US as 2%.  With the current rate of inflation in the Eurozone sitting at 0.1% following a year of deflation, that March 2017 target looks like a pipe-dream.

Draghi briefly addressed Brexit in his speech, saying "All we can say is that it is a risk that has materialized and it is a downside risk." This, too, is inline with the wait-and-see attitude that permeated the speech, and it's consistent with the approach being taken in the UK and US.  With the pending start of UK separation delayed until some time in 2017, fears of immediate turmoil have abated and none of the Central Banks are eager to take any action that might upset the tentative stability world economies have experienced over the last 3 weeks.  The word from all of them is that additional data is needed before any action (if action is warranted) can be considered.

With no major policy changes coming out of the ECB this month, the focus will now shift to Janet Yellen and the FOMC announcement on July 27th.  As with the ECB, no policy changes are anticipated in the US either, although the robust reaction of the stock market this month, combined with good corporate earnings and relatively good economic data have analysts anticipating a softening of the extreme dovish tone in their guidance on interest rates.  At this point, the market has factored in a 19.5% probability of a rate hike on September 21, up from 12% a week ago.  A December 14th rate hike probability has jumped to 40%, up from 30% last week.  It will be interesting to check these numbers following Yellen's announcement next week.

For now, it looks like the remainder of the summer will be uneventful from a Central Bank perspective.  That leaves only earnings and economic data to drive the markets, and both have been trending positive for much of July.

Happy Trading.

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