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Draghi Seeks Extended Calm in 2013 on Fading Euro Economy

European Central Bank President Mario Draghi will turn his attention to nursing the euro region back to economic health this week as the urgency to deploy emergency crisis measures recedes after three years.

Draghi’s Governing Council, which holds its first session this year on Jan. 10, will seek to extend the calm it’s instilled on markets with last year’s pledge to do anything in its power to end the crisis, economists said. While policy makers will probably keep interest rates unchanged for now, the threat of unlimited bond purchases has bought time to focus more on ending the region’s looming recession.

“Draghi’s threat is working,” Tobias Blattner, an economist at Daiwa Capital Markets in London, said in an interview. “Foreign investors are gradually coming back and Spain can live with the current yield levels,” he said, referring to a 10-month low in Spanish borrowing costs.

Draghi and European policy makers are returning to work with the turmoil that has ravaged the region’s bond markets at bay. Even so, they face potential pitfalls arising from mounting debt in Spain, next month’s parliamentary election in Italy and continuing austerity in Greece.

European finance ministers are also assembling a rescue package for Cyprus, the crisis’s fifth bailout.

Spanish Yields

The yield on Spain’s 10 year bond fell to almost 5 percent last week after closing 2012 at 5.27 percent, around the price at the beginning of last year and down from a July 24 high of 7.62 percent. The euro fell 1.1 percent against the U.S. dollar last week -- and slid 0.2 percent to $1.3039 at 10:20 a.m. in Frankfurt.

In a signal that investors are betting the worst of the crisis is over, euro nations are planning the biggest week of bond issuance in four months. Germany, the Netherlands, Italy, Spain, Austria and Belgium all plan to sell debt, the most since the week beginning Sept. 3.

Even as politicians and economists brace for recession, only three out of 45 economists in a Bloomberg News survey expect a rate cut when the 23 Governing Council members convene in Frankfurt. The central bank will keep the key rate unchanged at a record low of 0.75 percent until at least the first quarter of 2014, a separate survey showed.

Majority in Favor

Still, a majority of ECB policy makers were open to cutting the benchmark rate at the bank’s meeting in December after revising down economic and inflation projections that forecast a 0.3 percent contraction this year. Rates were kept on hold because of the negative signals a cut may send, three officials with knowledge of deliberations said Dec. 7.

“There are so many reasons against a rate cut,” Christian Schulz, a former ECB economist now working for Berenberg Bank in London, said. “First of all, it wouldn’t really achieve anything; secondly, policy makers are still unsure about the impact on the deposit rate; thirdly, it looks like we are reaching the bottom in terms of the economy and the Bundesbank would never agree to it.”

ECB Executive Board member Yves Mersch told Germany’s Frankfurter Allgemeine Zeitung in a Dec. 17 interview that unconventional measures are for now the ECB’s main policy tools “because they are more effective given the distorted transmission channel of conventional monetary policy.”

Stabilization Signs

For now, the task of the currency union will be to wrest the 17 member states out of an economic slump. European services and factory output contracted more than initially estimated in December, adding to signs the recession will extend into this year.

At the same time, there are some indications of stabilization in the global economy and in Germany, Europe’s largest economy. U.S. manufacturing picked up in December after dropping to a three-year low and China’s services industry grew at the fastest pace in four months.

Data last week showed German unemployment rising less than economists had forecast in December and business confidence increasing for a second month after demand from outside Europe boosted factory orders and exports.

“I remain confident that 2012 will go down in history as the year when it all turned,” Erik Nielsen, London-based chief global economist at UniCredit SpA (UCG), wrote in a note to clients. “I wouldn’t be surprised if the 2013 recovery turns out somewhat stronger than expected.”

Cyprus Talks

Finance ministers will seek not to rattle markets as they struggle with the possibility of writing off debt for Cyprus. While euro ministers have pledged not to repeat a Greek debt write-off, the International Monetary Fund is pushing for more sustainable financing.

Cyprus has been negotiating with the European authorities and the IMF over rescue financing since June. Chancellor Angela Merkel plans to join some European leaders for a meeting of the European People’s Party at the end of the week in the Cypriot port city of Limassol. Merkel also plans to meet with Greek Prime Minister Antonis Samaras tomorrow in Berlin.

Cypriot banks lost more than 4 billion euros ($5.2 billion) in Greece’s debt restructuring.

Luxembourg Premier Jean-Claude Juncker, head of the group of euro finance ministers, signaled last month that leaders would stand by their pledge, even as ECB Executive Board member Joerg Asmussen said that post-bailout debt levels for Cyprus might not be sustainable. Ministers will “almost conclusively” deal with Cyprus at this month’s meeting, Juncker said.

“It will be tough to explain to the northern European taxpayer that we have to act on Cyprus, still, it needs to happen,” Juncker said on Dec. 21.

To contact the reporters on this story: Patrick Donahue in Berlin at pdonahue1@bloomberg.net; Gabi Thesing in London at gthesing@bloomberg.net

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net

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