President Mario Draghi said the European Central Bank expects to keep interest rates low for an “extended period” as he tries to restrain market borrowing costs, in a new departure for an institution averse to setting policy in advance.
With ECB officials today leaving their main refinancing rate at 0.5 percent, Draghi fleshed out their outlook for monetary policy after investors pushed up long-term bond yields, threatening the region’s economic recovery. The statement came on the same day that the Bank of England also tried to manage investor expectations in Mark Carney’s first week as governor.
“The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time,” Draghi said at a press conference in Frankfurt. “What the Governing Council did today was to inject a downward bias in interest rates for the foreseeable future. Our exit is very distant.”
Stocks and bonds rose, while the euro fell after the comments. The remarks followed a surge in Portugal’s 10-year bond yield above 8 percent for the first time since November and a signal from the Federal Reserve that it may soon pull back monetary stimulus.
“This is as dovish as the ECB can get without actually acting,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt. “The new ECB stance should give investors comfort that the upside to yields is limited at current levels.”
The ECB chose words over deeds after an “extensive discussion” about cutting interest rates, and the support for the new language was unanimous, according to Draghi. He said the bank kept an open mind on whether to cut the deposit rate below zero.
“The Governing Council had all options on the table this month and will keep them there in case things worsen again,” said Christian Schulz, senior economist at Berenberg Bank in London. “This time, they decided against another rate cut and decided to stage a mini revolution by introducing forward guidance instead.”
The Stoxx 600 Index was 2.4 percent higher at 292.24 at 4:18 p.m. in Frankfurt. The euro declined to as low as $1.2883 from $1.2985 before the press conference. The yield on Portugal’s 10-year bond yield, which yesterday climbed as high as 8.11 percent, slid to as low as 7.11 percent.
By using so-called forward guidance, Draghi’s aim is to persuade investors that the ECB has no plans to end its easy policy stance so they in turn will keep longer-term rates low, paving the way for consumers and households to borrow cheaply and bolster economic activity. Historically, Draghi and predecessor Jean-Claude Trichet have said that the ECB “never precommits” to any future monetary policy.
Draghi said the reason for taking what he called an “unprecedented” step was the ECB’s expectation that the subdued outlook for inflation will extend into the medium-term amid broad-based weakness in the 17-nation euro-area economy.
“The risks surrounding the economic outlook for the euro area continue to be on the downside,” Draghi said, pointing to recent tightening in global financial conditions as one threat.
While all 23 members of the council agreed on the new strategy, Draghi declined to specify a time frame for the “extended period” and said several forms of guidance were debated.
The ECB hasn’t built formal frameworks or set specific economic targets for when policy makers assess the course of rates, according to an official familiar with the central bank’s deliberations. Instead, ECB officials will rely on the central bank’s traditional “two pillar” approach, a setup that looks at both money supply and a range of economic indicators, the person said.
At the same time, Carney and colleagues in the U.K. signaled they’ll keep their key rate at 0.5 percent for longer than investors expected. The “implied rise in the expected future path of bank rate was not warranted by the recent developments in the domestic economy,” the BOE said in a statement.
While euro-area unemployment rose to a record 12.2 percent in May, other indicators have signaled the economy may recover under current monetary policy given time. Confidence in the currency bloc jumped to the highest level in more than a year in June, a gauge of manufacturing and services output improved for third month and industrial output rose for a third month in April.
Still, financial conditions have recently tightened across the continent, posing a danger to the recovery. Bond yields in Portugal spiraled this week after the resignation of two of the nation’s ministers sparked concern austerity fatigue will derail fiscal reforms. Yields also climbed in Italy and Spain while declining in Germany, extending increases which accelerated after Chairman Ben S. Bernanke signaled his Fed may soon start curtailing its $85 billion of monthly asset-purchases.
With interest rates at or near rock-bottom levels, central banks have embraced more open communications about their thinking in the hope markets will respond. In March, Draghi said for the first time that policy “will remain accommodative for as long as needed.”
The ECB’s commitment today is nevertheless not as clear as those made elsewhere. As governor of the Bank of Canada, Carney pledged in April 2009 to keep its key rate at a record low until mid-2010. In December, Bernanke’s Fed introduced unemployment and inflation thresholds to govern when it could raise its benchmark from near zero.
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