The ECB left policy rates unchanged at today's meeting, contrary to our expectation of a small Refi rate cut. No new liquidity measures were announced at this stage. The new staff projections have revealed an inflation profile below target throughout the forecast horizon, at 1.5% on average in 2016, only picking up to 1.7% in Q416. Risks to price stability are still seen as broadly balanced, but the ECB might be in the process of revising its estimate of the output gap lower.
We forecast a small (10bp) cut in the ECB's main refinancing rate next week, but the surprising uptick in Eurozone core inflation in February does increase the risk of a delayed policy response. There remains a tactical case for pre-emptive easing, in our view, as the ECB staff forecasts should reflect downside risks to the medium-term outlook for price stability and March HICP will likely reach new record lows, especially if the EUR remains ‘too strong' for too long.
As the unemployment rate has approached the 7% threshold, the BoE reassessed the state of the economy alongside its February Quarterly Inflation Report. It confirmed expectations for a continued solid growth outlook going forward, underpinned by the reduction of uncertainty, easier credit conditions and the monetary policy stimulative stance.
The general tone of Chair Yellen's semi-annual testimony highlighted the continuity of monetary policy. QE will be phased out in a measured fashion and forward guidance policy remains the focus. Taper on. A high hurdle exists to deviate from continued measured reductions of asset purchases at future meetings. The financial system has been strengthened through regulatory and supervisory actions.
The ECB disappointed those expecting monetary easing today, although by merely arguing that not enough information was available our impression is that Draghi is trying to postpone such a decision. On balance, we believe that a March rate cut remains on the agenda.
The ECB's assessment of the medium-term outlook for price stability should remain broadly unchanged despite the lower-than-expected Eurozone HICP print in January. On balance, we expect the ECB to remain on hold on Thursday, but this is a close call. A small (10bp) Refi rate cut now looks more likely than not in March, if not in February, as the result of slightly lower HICP forecasts by the staff.
The decline in the UK unemployment rate over the past year has been significantly more rapid than expected by the BoE. A breach of the 7% threshold appears now imminent, meaning that only six months after the announcement of the BoE's forward guidance in August, the 7% threshold has become almost obsolete.
We expect the FOMC to announce a further $10 billion reduction in its monthly asset purchases to $65 billion, barring a destabilizing financial markets shock from troubled emerging markets. The Fed seeks to rebalance its monetary policy tools with a growing emphasis on forward guidance for policy rates. Communication will be key as this policy evolves. The changing composition of FOMC voters this year is not expected to alter the current thrust of monetary policy; although increased dissent is possible.
The ECB has made it clear that it will not tolerate an unwarranted tightening in money market conditions. Therefore, we continue to believe that new liquidity measures will be deployed to stabilise short-term rates. However, in a (demand-driven) full-allotment regime, there is no easy option for the ECB to maintain the desired level of excess liquidity. All the options have drawbacks.