3 Highlights from ECB Draghi’s Testimony

ECB Overlord Mario Draghi testified before the European Parliament’s Economic and Monetary Affairs Committee yesterday (June 21, 2016). And if you’re wondering why the euro took a dive, or if you just wanna know what he talked about, there here are the key highlights from his testimony.

ECB is ready for a Brexit

During the Q&A portion of his testimony, Draghi was asked about the Brexit referendum. Draghi refrained from giving his opinion on whether the “remain” or “leave” camp would win. And he also refrained from speculating on how substantial the economic impact of a Brexit would be, saying that “it is difficult to foresee the various dimensions of the vote on the markets and the euro area economies.”

He did say, however, that “the ECB is ready for all contingencies following the UK’s EU referendum” and that the ECB stands ready “to act by using all the instruments available within [its] mandate, if necessary.”

Views on the economy

Draghi stated in his, uh, statement before the Committee that economic growth in the euro area “is expected to proceed at a moderate but steady pace, supported by solid domestic demand,” as well as the positive effects of the ECB’s monetary policy measures on the real economy. In particular, the ECB measures have provided favorable financing conditions, which have resulted in an increase in business investment.

Draghi told the Committee that the current level of investment is “still unsatisfactory,” however, because they were still “more than 10% below pre-crisis levels,” and he then proceeded to ask for more action from the European Parliament.

Anyhow, the euro zone economy is expected to grow by 1.6% in 2016 and 1.7% in 2017 and 2018, as you can see on the table below. This is based on an anti-Brexit vote, though.

ECB Projection: GDP

Source: The ECB

Regarding inflation, Draghi said that annual headline inflation in the euro zone is still rather subdued and is “is expected to hover at low levels over the coming months.” This is so because past declines in oil prices haven’t fully passed through yet and wages “remain muted” due to economic slack, which means domestic inflationary pressure remains weak.

The ECB expects that the euro zone recovery will continue to strengthen, though, which would cut down on economic slack. The ECB therefore, expects that inflation will be slightly above zero in 2016, before accelerating to 1.3% in 2016 and then to 1.6% by 2018, as you can see on the table below.

ECB Projection: HICP

Source: The ECB

Draghi then kinda bragged in a way when he proclaimed that: “Without our policy stimulus, both growth and inflation would be significantly lower.”

By the way, if you’re interested on the breakdown per euro area member country, you can view it here.

More stimulus “in the pipeline”

The euro had a mixed performance but was mostly weak during Tuesday’s morning London session, likely because of the prevalence of risk appetite, which drew market players away from the lower-yielding euro towards the relatively riskier yet higher-yielding assets, namely European equities. However, the euro got kicked lower across the board shortly after Draghi started talking during the late London/U.S. session.

EUR/USD: 1-Hour Forex Chart

EUR/USD: 1-Hour Forex Chart

What was that about? Well, the heading already says it all, but let’s dig a little deeper.

Draghi said that “Further monetary policy stimulus is in the pipeline,” which means that further monetary policy stimulus is under way or in the process. And the market reaction indicates that most traders thought that Draghi was promising more easing down the road, but Draghi later said that “Additional impetus will come from the measures that are still at an early stage of implementation.”

Specifically, Draghi said that:

“Tomorrow we will start conducting the first operation of our new series of targeted longer-term refinancing operations (TLTRO II). TLTRO II will allow banks to secure long-term funding at very attractive conditions that can be as low as the deposit facility rate. This should further ease the borrowing costs of the private sector and provide an additional impulse to credit creation.”

This refers, of course, to the sixth item on the ECB’s March package, which are as follows:

  1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 5 basis points to 0.00%, starting from the operation to be settled on 16 March 2016.
  2. The interest rate on the marginal lending facility will be decreased by 5 basis points to 0.25%, with effect from 16 March 2016.
  3. The interest rate on the deposit facility will be decreased by 10 basis points to -0.40%, with effect from 16 March 2016.
  4. The monthly purchases under the asset purchase programme will be expanded to €80 billion starting in April.
  5. Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.
  6. A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched, starting in June 2016. Borrowing conditions in these operations can be as low as the interest rate on the deposit facility.

It therefore seems that the ECB is not cooking up another stimulus package just yet, and that Draghi was referring to the implementation of a stimulus measure that was already announced earlier, but the market didn’t seem to care about that at the time.