While the interest rate environment in the United States is still expected to remain stable for most or all of 2020, there are still likely to be negative interest rates outside of the United States. As long as those negative interest rates remain in place, chances are just that much higher that demand for U.S. Treasury notes and bonds will keep interest rates from rising rapidly here.
Thursday’s decision to keep interest rates flat by the European Central Bank (ECB) came with the warning that stimulus will remain in place and that negative interest rates are likely to remain for the foreseeable future. Christine Lagarde, the recently appointed President of the ECB, discussed on Thursday that the ECB’s current level of interest rates are expected to remain at their present level or even at lower levels until the bank has seen the inflation outlook “robustly converge to a level sufficiently close to, but below, 2%” and “within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.”
The long and short of the matter is that inflation is just not explosive and not even running hot, so the bank has more than ample room to keep its highly stimulative stance on track.
Euro area real GDP increased by just 0.3% on a quarterly basis in the third quarter of 2019 after the growth rate was just 0.2% in the second quarter of 2019. This reflects ongoing international trade weakness and continued global uncertainties. The ECB’s stance is that these issues have had an impact on manufacturing and have pressured investment growth in Europe. Similar to the United States, albeit at a lower rate, the ECB’s services and construction sectors have remained more resilient than manufacturing even as they moderated in the second half of 2019.
The ECB reported that euro area annual inflation increased to 1.3% in December 2019 from 1.0% in November based in part on higher energy prices while overall inflationary issues have remained muted. Broad money growth was 5.6% in November 2019 and has been broadly unchanged since August, while loan growth to firms and households have remained solid at about 3.5%. Trends in the fourth quarter indicated that there was weakening demand for loans to firms, but loan demand to households for house purchases continued to increase.
Based on incoming data and indicators, the ECB is currently expecting near-term growth rates to come in at similar rates as have been seen in recent quarters. An expansion of the euro area’s economy is expected to be supported by favorable financing conditions, additional employment gains, rising wages, the ECB’s fiscal stance and slower global growth. All in all, the risks appear top remain tilted to the downside, even if the risks appear to be less than in prior months, according to the ECB.
Lagarde further noted that the ECB is going to keep on its track of making net purchases under the ECB’s asset purchase program to the tune of 20 billion euro per month. Largarde’s statement further said:
We expect them to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.
We also intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favorable liquidity conditions and an ample degree of monetary accommodation.
One issue which is not as routine is that the ECB’s Governing Council announced a decision to begin a review of the ECB’s monetary policy strategy. In short, making sure that negative rates and buying any bond issuance in sight may need to be checked. Lagarde’s statement also addressed a baseline of economic growth, weakness within the economy, overall prices, and borrowing conditions. The statement said:
The incoming data since our last meeting are in line with our baseline scenario of ongoing, but moderate, growth of the euro area economy. In particular, the weakness in the manufacturing sector remains a drag on euro area growth momentum. However, ongoing, albeit decelerating, employment growth and increasing wages continue to support the resilience of the euro area economy. While inflation developments remain subdued overall, there are some signs of a moderate increase in underlying inflation in line with expectations.
The unfolding monetary policy measures are underpinning favorable financing conditions for all sectors of the economy. In particular, easier borrowing conditions for firms and households are supporting consumer spending and business investment. This will sustain the euro area expansion, the build-up of domestic price pressures and, thus, the robust convergence of inflation to our medium-term aim.
While inflation’s outlook remains subdued, the ECB’s current thought is that monetary policy must remain highly accommodative for a prolonged period even if the bank pledged to monitor developments. There is of course a statement that acts as “we can exit when needed” by noting:
In any case, the Governing Council continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.
Recent data at the start of 2020 from Bank of America indicated that there was still a global tally of more than $10 trillion in debt instruments with negative yields. That may be down from the $14 trillion or so that was counted as recently as August of 2019, but it’s still much more than just a massive figure.
While there are many potential outs and caveats, the ECB is starting its first formal meeting of 2020 by communicating that interest rates are going to remain stubbornly low for some time ahead. That’s likely to keep U.S. interest rates lower rather than much higher in turn.