THE ECB’s governing council made no change to its policy settings today when it met in Brussels even though inflation remains very low, at just 0.7% in April. That much was expected: market economists had been virtually unanimous in predicting the outcome. But speaking after the meeting Mario Draghi, the bank’s president, was surprisingly forthcoming about what was likely to happen at the next meeting, in June. The council was dissatisfied, he said, with unduly low inflation and was “comfortable” with acting next time.
What might that action be? Despite the recent flurry of discussion about the ECB following other central banks like the Fed and adopting quantitative easing—buying assets by creating money—that policy will be the last rather than the first resort for the council. Mr Draghi referred in particular to the recent strength of the euro in contributing to the current spell of low inflation. Although the ECB does not directly target the exchange rate, his remarks suggest that the central bank is most likely to lower interest rates, which would help to combat the currency’s unwelcome appreciation. Such a step would also be consistent with its forward guidance, to keep policy rates at “present or lower levels for an extended period of time”.
The two pertinent policy rates are the rate at which the ECB lends to banks, which was lowered last November to an already low 0.25%, and the one that it pays to banks leaving overnight funds on deposit with it, which has stood at zero since July 2012. The ECB could decide to lower the lending rate, say to 0.1%, or even lower, to zero, as the OECD recommended earlier this week. Though that would be a step in the right direction, it would lack punch unless the ECB also lowered the deposit rate, taking it into negative territory for the first time.
Such a move—charging banks for leaving funds at the central bank—would be a first for a big central bank. However, the policy was adopted by the National Bank of Denmark in July 2012 (after the ECB had lowered its deposit rate to zero). The Danish central bank took this step to fend off unwelcome upward pressure on the krone, which is pegged to the euro, at a time when the single currency was suffering from too little rather than too much affection. It set the rate on certificates of deposit initially at minus 0.2%, which went up to minus 0.1% in January 2013 as pressures on the krone subsided. The negative era has only recently ended. The National Bank of Denmark pushed the rate back into positive territory on April 24th, raising it to 0.05%, this time to counter a weakening krone.
Though one should be wary about reading too much into the experience of a small economy with a pegged currency, the Danish experiment seems to indicate that negative interest rates can help to contain upward pressures in the foreign-exchange markets. An additional advantage for the ECB is that the policy might encourage a revival in the interbank market, encouraging banks in northern Europe which are flush with funds to lend again to those in southern Europe that have been suffering from a drought of funding. On the other hand, if that does not occur, banks could try to compensate for the new expense by raising their lending rates, making the policy counter-productive.
Whatever the council does plump for in June, why wait until then, especially since Mr Draghi revealed that its discussions today had in effect previewed next month’s? The main reason, it appears, is that the ECB will then have available its latest set of staff forecasts (produced each quarter). The previous ones in March, which showed inflation averaging 1% this year and rising to 1.3% in 2015, already appear out of date especially for 2014. On May 6th the OECD forecast inflation would be only 0.7% in 2014, rising to just 1.1% next year. It would be surprising if the staff forecasts were not also lowered, supplying the final piece of evidence needed for the ECB to turn words to deeds.
