ECB Review: Downside growth risks but rate hike still on track

• Today, the ECB did not take any new decisions at its governing council meeting.

• It changed its growth risk assessment to be on the downside, along our non-consensus call.

• The ECB did not take a decision on the liquidity situation. Despite this, we keep our call for another liquidity round announced in March and implemented in June.

Uncertainty prevails

In line with our non-consensus call, ECB changed the growth risk assessment – unanimously – to the downside in light of continued weaker incoming data and persistent global uncertainties. This has been long overdue in our view and with January PMIs released earlier today just showing another strong dip, a balanced risk assessment would clearly have challenged the ECB's claim of being data-dependent. Despite of this, the likelihood of a recession in the euro area was still seen as ‘low' by the GC members due to favourable financial conditions, lower energy prices as well as the strong labour market developments supporting domestic demand. Mario Draghi hinted that the GC will reassess the implications from the slowdown for monetary policy at the March meeting. So far ECB's confidence for a wage-driven pick up a in core inflation remains clearly intact, although Draghi cautioned that the pass-through might take longer if the economic slowdown proves more persistent. This clearly points to a output-gap dependent modelling framework in the ECB.

Forward guidance – both date and state dependent

The ECB's decision was clear in both its date and state dependent aspect of the forward guidance. Markets are currently pricing the first rate hike by 20bp in 22 months (October 2021). Draghi stressed that when markets price a first rate hike in 2020 they are correct as they use the state dependent part of the forward guidance. As Draghi said, "markets understood the reaction function". Furthermore, Draghi repeated his reverse psychology argument (which he introduced in December) implying that no expectations for rate hikes in near the future supports the inflation and growth outlook.

That said, given the state dependent emphasis by Draghi, it is also important to stress that it also implies that if the economy picks up (as implied by the December staff projections), markets will have to reassess the pricing as rate hike is on the table. We therefore keep our ECB rate call for December by 20bp. We find the ECB pricing too dovish.

Liquidity operation

On liquidity operation, Draghi was not as clear as we had expected and struck an ambiguous tone. ‘Several speakers' mentioned the TLTRO but ECB is still assessing the impact on the liquidity situation approaching the summer. Furthermore, Draghi was very conscious of linking a potential new liquidity operation as a monetary policy transmission tool. We do not think a new liquidity operation is as clear cut as market participants suggest (some 90% expect liquidity operation in March).

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