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Asset purchases-ECB retains rates-keeps eye on euro!

The European Central Bank (ECB) maintained its ultra-low interest rates and asset purchase program, as widely expected, and while it acknowledged it was keeping an eye on the dampening impact of the euro’s recent rise on inflation, it also raised its forecast for economic growth and inflation slightly.

 

The ECB, the central bank for the 19 European countries that use the single currency, kept its benchmark refinancing rate at zero percent and the marginal lending rate at 0.25 percent – unchanged since March 2016 – and the deposit rate at minus 0.50 percent, unchanged since September 2019.

 

It also confirmed its guidance that it expects to keep these key interest rates unchanged, or at lower levels, until it sees the outlook for inflation converge to a level that is close to, but below, 2.0 percent.

 

As other countries with key interest rates at rock-bottom levels, the ECB has been purchasing assets to help stimulate economic activity, and while its governing council said it would continue these purchases, it also tweaked its statement slightly to reflect the slight upward revision of its inflation forecast for 2021.

 

Today it said these purchases were helping ease the overall policy stance and thus helping offset the “downward impact” of the pandemic on the projected path of inflation, a slight difference from July’s statement when it said the purchases were helping offset the “pandemic-related downward shift” in the projected path of inflation.”

 

In July the ECB almost doubled the size of its pandemic emergency purchase program (PEPP) to 1.35 trillion euros and extended it by a further six months to the end of June 2021, adding these purchases will continue until it judges the crises phase of the coronavirus is over.

 

The ECB today also confirmed it would continue to reinvest any payments from maturing securities bought under PEPP until at least the end of 2022, with net purchases under its older asset purchase program (APP) continuing at a monthly pace of 20 billion along with the purchases of an additional 120 billion under a temporary envelope until the end of the year.

 

Underscoring just how fixed a part of its monetary policy that asset purchases – or quantitative easing – has become, the ECB confirmed it expects to continue these monthly purchases under APP and they will “run as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.”

 

“The Governing Council continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry,” the ECB said.

 

In addition to the ECB’s massive stimulus, European Union governments in July agreed a landmark 750 billion euro spending package in response to the economic crises unleashed by the COVID-19 pandemic that would partly be funded by the collective sale of bonds, a first by the EU.

 

This EU package buoyed financial markets’ optimism over the prospects of a recovery of Europe’s economy, boosting the exchange rate of the euro against the U.S. dollar.

 

After steadily sliding against since April 2018, the euro hit a low of 1.066 U.S. dollars on March 20. Since then it has been firming and hit 1.199 on Sept. 1 before retreating, partly in response to speculation the ECB may boost its easing measures as a reply to the U.S. Federal Reserve’s recent adoption of an average inflation target, which is expected to lead to lower interest rates, for longer.

 

But in the wake of today’s slightly more optimistic outlook by the ECB, the euro bounced back to trade at 1.190 dollars, still below the recent high but up almost 6 percent this year.

 

Although ECB President Christine Lagarde underlined the “significant uncertainty” surrounding the strength of the euro area’s recovery, she said recent data “suggest a strong rebound” in activity and domestic demand has shown a significant recovery from low levels even as uncertainty continues to weigh on spending and investment.

 

Nevertheless, the strength of any recovery remains dependent on the evolution of the pandemic and the rise in coronavirus infection rates during the summer months constitute a headwind to the economic outlook in the short term, necessitating continued ample monetary stimulus, Lagarde said.

 

“At the same time, in the current environment of elevated uncertainty, the Governing Council will carefully assess incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook,” she said.

 

The economy of the euro area shrank 11.8 percent in the second quarter from the first quarter, slightly less than expected, but deeper than a 3.7 percent quarterly decline in the first quarter.

 

But economic output is on track to rebound in the third quarter, despite the dampening impact of the recent rise in infection rates, and ECB staff upgraded their forecast for growth this year to a contraction of 8.0 percent in gross domestic product as compared with the June forecast of an 8.7 percent fall.

 

For 2021 the euro area’s economy is seen expanding 5.0 recent, slightly down from 5.2 percent seen in June, and then by 3.2 percent in 2022, down from 3.3 percent.

 

“Overall, the balance of risks to the euro area growth outlook is seen to remain on the downside,” Lagarde said.

 

Despite a fall in inflation in August to minus 0.2 percent and expectations that inflation will remain negative in coming months debt to weak demand and a rise in the euro, ECB staff still kept its forecast for 2020 average inflation unchanged at 0.3 percent.

 

Helped by a recovery in demand, inflation in 2021 should rebound and average 1.0 percent, up from the June forecast of 0.8 percent, and rise further to 1.3 percent in 2022, unchanged from June.

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