European Central Bank: Leaving the options very open

As expected, at the end of last week the European Central Bank (ECB) cut rates 25bps, with the deposit rate now at 2.25%. The language was unchanged around being data-dependent, taking a meeting-by-meeting approach and not pre-committing to a particular rate path.

However, with a macro backdrop that is changing and highly uncertain, the need for policy “agility” was a focus. I expect them to cut further at the June meeting and 2.00% seems much less likely to be the floor for ECB rates this year than it was previously, but in the current environment it is difficult to have much confidence in any particular central path.

In the statement they describe the outlook for growth as having deteriorated given trade tensions.

They continue to refer to the disinflation process as “well on track” and “most measures of underlying inflation suggest that inflation will settle at around the Governing Council’s 2% medium-term target on a sustained basis”. However, in the statement they describe the outlook for growth as having deteriorated given trade tensions. As for what that means for policy going forward, they kept the line that “especially in current conditions of exceptional uncertainty, it will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance” [my italics].

Where to now? Leaving their options very open

• First, neutral isn’t sounding relevant right now as an anchor or indication of the likely direction of policy: The deposit rate is now around/very close to the rate where most had been thinking ‘neutral’ rates were. Indeed, they dropped the part in the statement describing the restrictiveness of policy (last time: “monetary policy is becoming meaningfully less restrictive”). However, rather than say that was dropped because they are now close to neutral, Lagarde made the point that neutral is a concept that “works for a shock-free world” and that “anybody in this room” who thinks we are currently in a shock free world “would I suggest maybe… have their head examined”. She said that, with that in mind, the assessment on restrictiveness “is not operative anymore”.
• Second, no comment on the direction of travel: Lagarde said that “what we now need to do is determine the appropriate monetary policy stance that will take us to our destination. And I will not comment on the direction of travel”. That makes sense while they see the impact of tariffs as negative for growth but less clear for inflation. They think that the impact on inflation will only become clear over time.
• Third, agility the new watch word: While the decision this week was unanimous, she said that options were debated (and it sounded as if that discussion ran to both pausing and cutting 50bps, even if no one actively argued for that). Now, she said the monetary policy stance will be determined by readiness and agility (in the face of uncertainty). She said that in their monetary policy decisions they “have to stand ready for the unpredictable”. She said that they must be attentive to new developments and that it wasn’t a question of rushing to a particular stance but of agility in the face of what they are seeing. She talked, however, of them having more information by the June meeting–including on the fiscal front. She said that when they are not too sure, they do scenario analysis, and that exercise will give rise to “some serious results at our June meeting”.

To me, that makes it clearer than ever that they don’t want to be boxed in to particular policy decisions in the current environment. Stressing agility also suggests perhaps that they may want to prepare the ground for the possibility of bigger than 25bps changes if they feel those are needed, changes in monetary policy direction, and decisions on instruments other than interest rates, as things develop.

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