ECB Interest Rates May Stay at Record Lows until after 2019 say Economists

-ECB minutes show solid support for low interest rate guidance.

-Rates at record lows until at least end of 2019, possibly into 2020.

-EURUSD to remain "flat" in lieu of confidence in timing of rate rise.

© Grecaud Paul, Adobe Stock

The European Central Bank (ECB) may keep its interest rates at record lows until after 2019, stifling the Euro's performance against rival currencies, according to economists and analysts covering Eurozone monetary policy. 

This latest commentary comes closely behind June's ECB statement, which saw the bank announce a surprise end to its quantitative easing programme but crush earlier market hopes of an initial interest rate rise around June 2019.

The official line from the ECB is that rates will remain at their present levels "at least through the summer of 2019". But recent press speculation has suggested there are deep divisions among policymakers that could still see the bank raise its interest rate during the summer of 2019 or toward the end of that year.

However, minutes from the June policy meeting were released this Thursday and have left some currency analysts and economists sceptical of this claim. 

"There have been reports of divisions on the Governing Council, with several members apparently preferring an earlier hike. But there is very little evidence of this in the minutes and the new guidance seems to have been supported by a large majority. Indeed, it was felt that “the open-ended character” of the forward guidance on rates “should be emphasised”, implying that interest rates are more likely to be on hold for more than a year than for less," says Jennifer McKeown, chief European economist at Capital Economics.

The ECB has held its interest rates at record lows and bought tens of billions worth of Eurozone bonds each month since early 2015 in an effort to stimulate the economy and spur inflation. This has kept Eurozone bond yields low at a time when yields of other nation's government bonds are rising, which has incentivised international investors to sell their European government bonds and their Euros in order to buy other currencies and invest elsewhere. 

ECB policies have kept the Euro pinned down at depressed levels relative to the US Dollar in recent years and any sustained recovery will first require an end to quantitative easing, which is expected to happen in December 2018, and an increase in the bloc's interest rates. But increasing numbers of market participants are doubtful as to whether this will happen any time soon. 

"Something completely unexpected may have to happen for the ECB not to stick to unchanged rates “at least through the summer”. EU aficionados should know: the official European summer break always ends in the last week of August – so it’s likely that September is the earliest the ECBwill hike. This will render the EUR pretty flat for now – at least until sentiment over ECB tightening gains traction," says Viraj Patel, an FX strategist at ING Group

Changes in interest rates, or hints of them being in the cards, are only normally made in response to changes in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

Eurozone inflation rose back to the 2% target in June but the more important measure of core inflation, which removes volatile food and energy prices from the goods basket, fell by 10 basis points to 1% during the same month. If anything, this suggests inflation pressures still have some way to go before ECB officials can be confident the consumer price index will remain close to its target without the central bank providing stimulus to the economy. 

"Growth is set to remain strong in 2018 and 2019, at 2.1% this year and 2% next year in both the EU and the euro area. However, after five consecutive quarters of vigorous expansion, the economic momentum moderated in the first half of 2018 and is now set to be 0.2 percentage points lower in both the EU and the euro area than had been projected in the spring," the European Commission says.  

Thursday saw European Commission officials downgrade their forecasts for the Eurozone economic growth this year and next, citing an escalation in the so called trade war between the US, China and the EU which is expected to dent business confidence and crimp activity during the months ahead. A stronger Euro and oil prices, which have risen by nearly 20% in 2018, were also cited as headwinds to growth. 

Slower economic growth will merely detract from the inflationary pressures the ECB has worked so hard to stimulate during recent years and so, if anything, downgrades to European Commission forecasts mean an ECB interest rate rise is still moving further out along the 2019 and 2020 timeline. However, and while increasing numbers doubt an interest rate rise in the summer of 2019, not everybody is downbeat enough to think the central bank will still be sat on its hands in 2020. 

"There has been increased speculation and market chatter about the ECB's next steps, be that an operation twist or rate hikes in the summer of 2019. In our view, these talks are premature," says Carsten Brzeski, chief Eurozone economist at ING Group. "It is obvious that the broad majority of ECB members seems determined to QE, though as quiet as possible, and would like to return to interest rates as the main policy tool. This, however, does not necessarily mean that they will be in a hurry to hike rates."

Brzeski and the ING Economics team flag that ECB President Mario Draghi's term in office will expire at the end of 2019, which leaves him with only the September and October/November meetings in which a rate hike could be agreed before he departs the bank. They forecast that Draghi and the governing council will use "at least one of these two meetings" to begin lifting Eurozone interest rates up from their post-crisis lows. 

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