1. Review of financial, economic and monetary developments and policy options
Financial market developments
Mr Cœuré reviewed recent financial market developments.
Since the Governing Council’s monetary policy meeting on 2-3 June 2015, financial markets had again been characterised by volatility, in part driven by uncertainty related to developments in Greece. The Eurosystem nevertheless continued to smoothly execute the expanded asset purchase programme (APP), in line with the announced moderate frontloading of purchases.
Starting with developments in the euro area bond markets, the period around early June 2015 had been characterised by a second sell-off, following the earlier episode from late April to mid-May. Between 1 June and 10 June the yields on 30-year German government bonds had risen by 64 basis points, to 1.79%, while those on ten-year benchmark bonds had risen by 52 basis points, to 1.06%, and on 10 June 2015 stood at their highest level since September 2014. The largest yield changes had taken place at longer maturities, leading to a further steepening of the yield curve, whereas the short end of the curve remained well anchored. The bond yields of several other euro area countries had also been affected, albeit to a lesser extent. Over the same period the yields on the ten-year and 30-year Spanish, Italian and Portuguese government bonds had risen by 44 basis points on average, leading to a spread compression of around 20 basis points on 30-year bonds.
According to market participants, the two sell-off episodes had been partly the result of an overvaluation of euro area government bonds, when assessed against traditional valuation measures. [...]
Despite volatile market conditions, the Eurosystem had continued to smoothly implement a moderate frontloading of purchases and, as a result, Eurosystem APP holdings had risen by €63.2 billion in June, following a similar increase in May. [...] The universe of eligible securities under the PSPP was enlarged with effect from 2 July 2015, with the addition of 13 public sector entities to the list of eligible agencies. Furthermore, also with effect from 2 July, following the positive outcome of the review by the Board of Directors of the European Stability Mechanism, Cypriot government bonds had become eligible for PSPP purchases, in line with the ECB’s Decision of 4 March 2015 on a secondary markets public sector asset purchase programme (ECB/2015/10). [...]
With regard to purchases of asset-backed securities (ABS), the Eurosystem had bought €1.6 billion in June, bringing the book value of holdings under the ABS purchase programme to €8.8 billion at the end of that month, with 25% purchased in the primary market.
Asset purchases by the Eurosystem had been one of the two main drivers of the increase in excess liquidity in the euro area, with a net injection of €81 billion through monetary policy portfolios since the previous monetary policy meeting. The second major driver had been the settlement of the fourth targeted longer-term refinancing operation (TLTRO), which had added €74 billion of liquidity on 24 June 2015. Taking into account all factors, excess liquidity had increased by €100 billion since the monetary policy meeting in early June and currently stood above €400 billion.
In the euro area money market, the decline in interest rates had been limited, despite the large increase in excess liquidity. The EONIA had averaged -11.8 basis points since the beginning of the current maintenance period, compared with -9.8 basis points in the previous period. Overall, short-term money market rates had remained broadly stable, unaffected by the re-pricing in bond markets and by the uncertainty related to Greece.
Turning to Greece, the unexpected decision on 27 June 2015 by the Greek Prime Minister to call a referendum and the subsequent “No” vote on 5 July had led to a significant re-pricing of Greek government bonds, notably for shorter maturities. Subsequently the agreement by the euro area Heads of State and Government on 13 July 2015 was accompanied by a strong rebound in the value of Greek bonds. Some spillover effects from the events in Greece had been observed in the euro area bond and equity markets, but, overall, contagion to other euro area countries had been limited. After the agreement on Greece had been reached on 13 July, key financial indicators for the euro area had broadly recovered. Market analysts commented, however, that the risks had not subsided completely, in view of the significant challenges associated with the negotiation and implementation of a third economic adjustment programme for Greece.
Moreover, in the money markets, there had been no signs of contagion to banks in more vulnerable countries and normal funding conditions had been reported. Similarly, the forward EURIBOR-OIS spread, a measure of credit risk, had increased only marginally and thereafter had returned to levels close to those prevailing before the announcement of the referendum.
In the foreign exchange market, the value of the euro had remained relatively stable, in nominal effective terms. [...]
Developments in equity markets had been mainly dominated by the negotiations with Greece. European stocks had seen the largest moves, falling sharply after the breakdown of negotiations and the referendum, but recovering the losses after an agreement on Greece was reached on 13 July. US and Asian stocks had shown a similar pattern to their European counterparts, including with respect to volatility.
Finally, with regard to developments in international markets, following the agreement on Greece on 13 July the focus had seemed to be shifting towards China and the United States. In China, the Shanghai Composite Index had declined by more than 20% since 12 June 2015, after having risen by more than 150% in less than a year, accompanied by growing concerns about the valuation of the Chinese equity markets. The People’s Bank of China had reacted to this decline by cutting benchmark interest rates and decreasing reserve requirements. Developments in Chinese financial markets had reportedly exerted some pressure on commodity prices. Brent crude oil prices had declined since 1 June, falling by more than 12% at the trough. In market analysts’ view, the greater odds of a successful deal in the nuclear negotiations with Iran, as well as the International Energy Agency’s report on the oversupply of oil, had also contributed to the decline.
The global environment and economic and monetary developments in the euro area
Mr Praet reviewed the global environment and recent economic and monetary developments in the euro area.
Following a slowdown in the pace of economic expansion in early 2015, the latest surveys suggested that the global economy had returned to a modest and uneven recovery path in the second quarter. While the average global composite output Purchasing Managers’ Index (PMI) for the second quarter of 2015 had fallen slightly compared with the previous quarter, it remained above the level recorded in the fourth quarter of 2014. At the same time, quarterly PMIs had declined for major emerging market economies (EMEs). Global trade momentum had remained weak, with the volume of world imports continuing to decline, falling by 1.1% in three-month-on-three-month terms in April, although at a slower pace than in the first quarter. This mainly reflected continued weakness in activity in EMEs. Annual OECD CPI inflation had increased to 0.6% in May, from 0.4% in April, while inflation excluding food and energy had remained unchanged at 1.6% in May.
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Monetary policy considerations and policy options
Summing up, Mr Praet noted that the data that had become available since the Governing Council’s previous monetary policy meeting in early June had broadly confirmed expectations. Real GDP growth in the euro area was proceeding in line with a broad-based moderate recovery, while downside risks prevailed. The outlook for price developments over the medium term was also by and large unchanged. [...]
Overall, the Governing Council’s monetary policy stance remained accommodative. Notwithstanding recent increases in long-term market interest rates, credit markets had continued to improve, both in terms of prices, when looking at bank lending rates, and in terms of non-price conditions. It was noteworthy that the range of monetary policy tools available – notably the TLTROs, the APP and the Outright Monetary Transactions – had preserved the accommodative monetary policy stance in an environment which remained difficult and subject to financial market and confidence shocks, thereby supporting the Governing Council’s baseline scenario. [...]
2. Governing Council’s discussion and monetary policy decisions
Economic and monetary analyses
With regard to the economic analysis, the members of the Governing Council generally shared the assessment of the outlook and risks for economic activity in the euro area, as presented by Mr Praet in his introduction. Incoming data pointed to a continuation of the moderate economic recovery, in line with earlier expectations. Looking ahead, the recovery was expected to broaden further, as foreseen in the June 2015 Eurosystem staff macroeconomic projections for the euro area, with risks remaining tilted to the downside.
Recent data broadly confirmed the continuation of moderate growth during the second quarter of 2015. Uncertainties stemming from developments in the Greek programme negotiations and from the deteriorating economic and financial conditions in some EMEs, most notably China, did not appear to have had a discernible impact on euro area economic activity. This pointed to a certain degree of robustness of the ongoing recovery, as supported by some country-specific developments.
At the same time, there was a continued need for caution as some recent data had been weaker than expected. In particular, the decline in euro area industrial production in May 2015 – down 0.4% from April – pointed to remaining weaknesses and uncertainties surrounding current economic developments,[...].
Overall, the recovery in the euro area was expected to remain moderate and gradual, which was considered disappointing from both a longer-term and an international perspective, as real GDP currently stood only close to its 2008 level in the euro area, while in the United States it had registered a significant rebound.
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Overall, members concurred that euro area inflation, while remaining low, was expected to develop in line with earlier expectations and with the June Eurosystem staff projections. [...]
With regard to the monetary analysis, members agreed with the assessment, presented by Mr Praet in his introduction, that money and credit dynamics had continued to recover, with credit growth gradually improving further, although it remained subdued overall. Recent data had confirmed robust growth in broad money (M3), which continued to be strongly supported by a further pick-up in the narrow monetary aggregate M1.
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The overall improvement in the credit channel was seen to provide evidence of the effectiveness of the monetary policy measures that had been put in place since June 2014. Improved funding conditions were feeding through to borrowing conditions for firms and households and, thereby, were helping to strengthen, albeit not uniformly across the euro area, both credit supply and demand. In particular, the TLTROs had helped to improve credit supply, possibly more than generally expected, as reflected in credit terms and conditions. [...]
Monetary policy decisions and communication
Overall, taking into account the views expressed, the President concluded that the Governing Council was unanimous in its assessment that a steady monetary policy course should be maintained. It stood ready to use all available tools within its mandate, if necessary. This entailed reaffirming that the full implementation of all adopted monetary policy measures was needed to provide the necessary support to the economic recovery in the euro area, to achieve a sustained return of inflation rates towards levels below, but close to, 2% in the medium term, and to underpin a firm anchoring of medium to long-term inflation expectations.
At the same time, this also entailed the need for a close monitoring of the situation in financial markets, with a view to their implications for price stability, and a readiness to respond to an unwarranted tightening of the monetary policy stance or a change in the medium-term outlook for price stability. Taking into account the foregoing and on a proposal from the President, the Governing Council decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility would remain unchanged at 0.05%, 0.30% and -0.20% respectively.
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