European Central Bank

The European Central Bank (ECB) continues to establish itself and its inflation fighting credentials. Founded by the European Union, the ECB is empowered to set monetary policy for the 18 countries which make up the European Monetary Union. In 2002, the ECB's biggest challenge was the conversion of the national currencies (i.e. the deutschmark, franc, lira, drachma etc) to the euro for all day to day transactions.

 

The ECB's governing council consists of 23 members representing the six members of the Executive Board and the governors of the national central banks of the 19 euro area countries. The council performs tasks similar to that of the Federal Reserve Open Market Committee (FOMC). They make decisions affecting the availability and cost of money and credit in member countries. Both make decisions about interest rate and money supply growth targets — although their approach differs in the decision making process. Critics are vocal in complaining about the ECB's lack of transparency. The ECB began publishing minutes of their meetings in 2015. The ECB President holds press conferences after its monetary policy meetings to explain its actions. Decisions are made by consensus — no vote is taken.

 

The European Central Bank decides monetary policy and member national central banks implement it. Together these banks form the European System of Central Banks (ESCB). The president is Mario Draghi, a former governor of the Bank of Italy, who began an eight year term on November 1, 2011. The Bank was patterned after the German Bundesbank and follows many of its ways of doing business.

 

 

The ECB's prime objective is to maintain price stability through interest rate policies. The ECB makes decisions on interest rates by majority vote of its governing council as does the Federal Reserve. However, it differs in that it does not release a voting record. The council meets every other Thursday — just as the Bundesbank does — and more frequently than the FOMC but focuses on monetary policy only during the first meeting of the month except in crisis. The main monetary instrument is the repurchase rate (repo).

 

The ECB has adapted two policy guides —

• a monetary target of 4.5 percent growth of the M3 measure of money supply
• an inflation ceiling of 2 percent or less as measured by the harmonized index of consumer prices.

 

 

The ECB increased its key interest rate to 4.25 percent at its July 2008 meeting. Further rate increases were in the offing but did not occur because of August's chaos in financial markets. The ECB is driven by a treaty-mandated inflation target of no higher than 2 percent. The ECB initially had been concerned about secondary effects of high energy prices. The Governing Council was also concerned that money supply growth was growing at over double their 4.5 percent reference target. The pace of money supply growth slowed dramatically and now is growing only 1.2 percent on the year. The lack of growth in M3 is an indication of how weak bank lending has become. Inflation as measured by the harmonized index of consumer prices has weakened throughout 2013 and was up 0.7 percent on the year in February — very much below the ECB's 2 percent target.

 

Despite plummeting growth, the ECB was intent upon continuing its inflation fight and did not join the Federal Reserve, Banks of Canada and England in lowering interest rates during the summer of 2008. The ECB continued to hold fast until the coordinated interest rate reduction on October 8, 2008 when it joined the Fed, Banks of Canada and England and others and cut rates by 50 basis points to 3.75 percent. The ECB continued to cut rates in a measured fashion. It cut its key rate to 1 percent in May 2009. Because of its focus on inflation, the ECB increased interest rates twice — in April and July 2011. Even with the stresses of the sovereign debt crisis the ECB held fast to its mandate — but did make loans more accessible to banks.

 

One of the first moves by the new ECB president Mario Draghi was to lower interest rates which he did at both the November and December 2011 meetings. He has also increased liquidity by making loans available to banks at low rates for an extended time period. The ECB lowered its key refinance rate to 0.75 percent at its July 2012 meeting after the EU agreed to a series of moves to help Spain. The ECB lowered its key interest rate to 0.5 percent at its May 2013 meeting — inflation certainly was no worry given its 1.2 percent increase.

 

At its much awaited September 2012 meeting, Mr Draghi announced a bond buying program to help beleaguered Spain and Italy. However, the caveat is that any outright monetary transactions (OMTs) will be subject to the conditions laid down by the relevant EFSF/ESM adjustment program, ideally with input from the IMF. Moreover, any addition to liquidity will be sterilized. This means that the use of OMTs will not constitute quantitative easing. The program has not yet been used.

 

At its November 2013 meeting, the ECB surprised bank watchers and lowered its key refinance rate to 0.25 percent. It did so because inflation as measured by the harmonized index of consumer prices continued to decline below the ECB's inflation target of just below 2 percent. The latest measure of the HICP continues to indicate low inflation, below 1 percent at 0.5 percent. The flash reading for May resulted in further moves by the ECB to combat deflation.

 

At its June 5 meeting, the ECB cut the main refinancing rate by 10 basis points to 0.15 percent from 0.25 percent. The deposit rate was cut by 10 basis points to minus 0.10 percent and the marginal lending facility was cut by 35 basis points to 0.40 percent. During his press conference Mr Draghi said that ECB was reaching the lower bounds of interest rate reductions bar some minor technical points.

 

The ECB introduced a €400 billion four year program of targeted long term financing operations that are focused on non-financial Eurozone companies and can account for a maximum 7 percent of the bank's overall loans in the currency bloc.

 

ECB said it is "intensifying preparatory work" to get the asset backed security market going again, but it needs cooperation of other institutions including regulators to enable simple, real and transparent products to be made available. The ECB will stop sterilization. This means it will halt operations which mop up the liquidity added to the system by the Bank's purchases of government debt through its Securities Markets Programme. At the moment, the ECB mops up around €165 billion each week. Fixed rate full allotment liquidity auctions were extended.

 

At its July meeting, the ECB announced that it would begin meeting every six weeks instead of monthly as it does now. It would also introduce minutes of its meetings. The Federal Reserve, Banks of England and Japan and the Reserve Bank of Australia currently publish minutes of their respective monetary policy meetings.

 

In September, the ECB surprised the markets and lowered its key rate to 0.05 percent. The move was made after the HICP continued to weaken. Inflation is now a meager 0.4 percent on the year. The ECB left policy unchanged in October and November.

 

In December, the ECB confirmed that minutes of its regular policy setting meetings will be published for the first time in 2015. The new procedure will come into effect with its deliberations scheduled for January 22. However, anyone hoping that the accounts will be released at the same time as the policy announcement (as per the BoE's recently indicated proposals) will be disappointed. Rather, there will be a four week lag, a week longer than currently employed by the FOMC. ECB has also said that it will be replacing its current Monthly Bulletin with a new Economic Bulletin that will be published two weeks after each meeting.

 

At its January 22, 2015, the governing council meeting, the ECB probably more than matched market expectations. Quantitative easing will be introduced from March and run through to the end of September 2016 with the option of an extension should inflation goals remain out of reach. Including the existing asset backed securities (ABS) and covered bond programs already announced, total buying going forward will be €60 billion a month directed at maturities between two and thirty years. On this basis the total package could be worth around €1.1 trillion. Sovereign bonds under consideration will need to be of investment grade and about 80 percent of the risk will be carried by the national central banks. The ECB will also trim the rates on future targeted long-term repo operations (TLTROs) to match the prevailing refi rate. The ECB began buying bonds on March 9, 2015.

 

The January meeting marked the first in the ECB's new every six week meeting schedule rather than the monthly meetings held before. The Governing Council also has begun rotational voting now that there are 19 members. There are two groups aside from ECB board members. Group one includes Germany, Spain, France, Italy and the Netherlands. All other members are in group two. For group one, voting members rotate each month. No subsequent changes were made to monetary policy at subsequent meetings held on March 5, April 15, June 3 and July 16.