Today, true to form, the ECB decided to leave its monetary policy on hold despite the many reasons one might have expected that it might have taken a more proactive policy stance. This is unfortunate since it heightens the probability that the European economy will sink deeper into recession during the course of 2013, which is all too likely to reignite the European sovereign debt crisis.
The ECB is now falling behind the policy curve due to its own assessment of the European economic situation. This points to the appropriateness of a more aggressive monetary policy stance. Not only does the ECB acknowledge that the European economy contracted in the second and third quarter of last year, but it expects that the economy contracted in the fourth quarter and will remain weak in the early part of 2013. Furthermore, the ECB recognizes that there are considerable downside risks to its forecast of a modest economic recovery later in the year.
The ECB’s reluctance to be more aggressive might have been understood were there a real risk that its objective of keeping inflation at below 2% was in jeopardy. However, the ECB estimates that inflation in January 2013 declined to 2% while, on the basis of current future prices for oil, the ECB expected inflation to decline further to below 2% in coming months. In addition, the ECB has noted that inflationary expectations remain very well anchored and that the underlying pace of monetary and credit expansion continues to be subdued.
Yet a further reason one might have expected the ECB to have taken a more accommodative monetary policy stance is the sharp recent appreciation of the euro, which must be expected to both curb export growth and exert downward pressure on inflation. Over the past few months, the euro has appreciated by around 20% against the Japanese yen and by about 10% against the US dollar. And there is every prospect that this appreciation could continue as the US Federal Reserve, the Bank of Japan, and the Bank of England all engage in aggressive quantitative monetary policy easing.
The only plausible reason for the ECB’s undue caution is that it might be fearful of opening up a second front in its battle with the Bundesbank ahead of the German elections in September 2013. This might be understandable given how antagonistic the Bundesbank has been to the ECB’s Outright Monetary Transactions program and how hard a line the Bundesbank takes on inflation. If this is indeed the case, it has to be regretted. The last thing that Europe now needs is a central bank that will be inhibited by political considerations from taking the necessary action to limit the risk of an ever-deeper European economic recession.