The European Central Bank (ECB) announced at its meeting this week that it would be delaying its first rate hike until at least 2020 In addition to this, Draghi confirmed they will be providing banks with an alternative and more economical facility to borrow funds. At present, growth is projected to be only 1.1% versus the previously forecasted 1.7%. When comparing these gloomy predictions against the ECB's actions at the end of 2018, stopping its asset purchase program and projections towards higher rates for the coming year, it seems like an abrupt shift. Thus raising the question: has the ECB made a policy mistake?
In the previous two calendar years, global growth has picked up significantly. This increase in activity gave central banks across the world a greater degree of confidence to step away from crisis era policies and move towards a more normalised stance. The US Federal Reserve was the most aggressive in its policy tightening given the strong labour market and the impetus from Trump's fiscal policy. Despite the deadlock of Brexit, the Bank of England also reacted to these better prospects and raised rates on two occasions. In light of the actions taken by its peers, the ECB also wanted to take advantage of this improved backdrop and move away from its ultra-accommodative policy stance. It gradually reduced purchases from a crisis high level of €80 billion a month in 2016 to zero over the course of 2017 and 2018. In the second half of last year, global growth became increasingly challenged by the uncertainty surrounding trade policy and tariffs. The Eurozone has experienced its share of domestic issues, such as a populist Italian government and its proposed windfall budget driving the Italian borrowing cost sharply higher, whilst yellow vest protests and car emission issues respectively, challenged growth in France and Germany. Yet despite these wider issues, the ECB remained keen on exiting its crisis policy and classified these issues as mere one-offs.
The latest action by the ECB suggests that they underestimated the constraints on growth and are now trying to stimulate the Eurozone economy in order to avoid a wider recession. Italy is already in a recession, with negative growth of -0.1% in the third and fourth quarters of last year. Germany contracted by 0.2% in the third quarter, narrowly avoiding a recession with growth close to flat in the last quarter of 2018. With two of the largest European economies tethering on the brink of recessions, it appears that the ECB committed a policy mistake and their latest actions appear as hope to address that. Based on the market reaction following the announcement, investors remain unconvinced as to whether they have done a large enough shift to see the currency bloc move back sustainably to a better growth picture. The ECB has now eroded some credibility and it may take further action to restore that.