“We may experience a prolonged period of low inflation,” Draghi said at a news conference in Frankfurt today, echoing language he used last month after the ECB unexpectedly cut interest rates. Today, the ECB kept its main rates unchanged.
Draghi reiterated his commitment to keeping borrowing costs low “for an extended period of time” as policy makers continue their deliberations over whether they have done enough to prevent deflation and support the region’s recovery, or whether they need to embrace measures such as a negative deposit rate.
Draghi said that officials had a “brief discussion” on whether to cut the deposit rate and hinted that any future offerings of unlimited liquidity to banks will have conditions attached.
The euro rose to $1.3668 after trading at $1.3580 before Draghi spoke. The yield on Germany’s benchmark 10-year government bond rose to the highest in almost seven weeks, by 4 basis points to 1.85 percent.
Today’s projections show that “the ECB expects an inflation rate near its target at the earliest by the end of 2015,” said Mario Gruppe, an economist at NordLB in Hanover, Germany. “If the credit tightness and low inflation levels persist, it’s only a matter of time before the ECB injects more liquidity -- but then under conditions.”
The ECB forecasts inflation at 1.1 percent in 2014, 0.2 percentage point lower than the previous prediction. It sees inflation at 1.3 percent in 2015, the first time it has made a forecast for that year. The economy will contract 0.4 percent this year, unchanged from the previous forecast, the ECB said. It will expand 1.1 percent in 2014 and 1.5 percent in 2015. In September, the ECB forecast 1 percent growth next year.
“We are monitoring developments closely and are ready to consider all available instruments” said Draghi. “There’s a sizable variety of instruments. We’re ready and able to act within our forward-guidance framework.”
Draghi said that ECB policy makers want to make sure that any future offerings of long-term cash find their way into the economy, rather than being hoarded by banks. Bank lending in the euro area to companies and households shrank 2.1 percent in October from a year earlier, the 18th consecutive month of declines, according to ECB data.
“We want to make sure that this operation is not going to be used for subsidizing capital formation by the banking system under these carry-trade operations,” he said. In previous allotments “not much of this actually found its way into the economy.”
Readiness is “pretty high” on a range of non-standard meaures, he said, without being more specific.
Since the ECB cut its key rate last month, data has shown that the euro area’s economic rebound came close to a halt with growth of just 0.1 percent in the third quarter. The French economy unexpectedly shrank and Italy extended its longest postwar recession.
“President Draghi emphasized that the Council is fully aware of the risks involved in a protracted period of low inflation,” said Richard Barwell, senior European economist at Royal Bank of Scotland Plc in London. Still, “the market did not learn much in terms of the specifics of the trigger for unconventional instruments or which instrument will be selected in which circumstances.”
Euro-area inflation was 0.9 percent in November, compared with the ECB’s target of just under 2 percent, and prices are stagnating or declining on an annual basis in five of the 17 euro nations.
One unprecedented option that officials have discussed is charging banks for the excess liquidity they park at the ECB, which would make it the first major central bank to venture into negative deposit rates.
One risk of such a move is that banks are unable to pass the cost onto their depositors, squeezing their profit margins and deterring them from lending to companies, households or each other.
Bloomberg News reported on Nov. 20. that officials are weighing a smaller-than-usual cut in the deposit rate to minus 0.1 percent to minimize any disturbance. ECB Vice President Vitor Constancio said in an interview on Nov. 27 that the policy would be invoked only in “quite extreme situations” and the council is “not really near a decision.”
Constancio said last month that banks’ access to funding has improved and “is not the main cause of concern,” suggesting that measures to increase liquidity such as new long-term loans aren’t imminent. Banks have returned almost 40 percent of the 1 trillion euros ($1.4 trillion) in emergency cash they borrowed for three years at the height of the financial crisis in 2011 and 2012.
“Three weeks before Christmas, the ECB took a pause in action,” said Christian Schulz, senior European economist at Berenberg Bank in London. “But the very subdued monetary and credit developments keep the ECB on alert. More decisions to boost credit growth remain possible and the ECB discussed a wide range of them, without taking action at this stage.”
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