Dec. 6 (Bloomberg) -- The European Central Bank cut its growth and inflation forecasts and President Mario Draghi said the euro area won’t start to shake off its slump until the second half of 2013, leaving the door ajar for further interest-rate reductions.
“Weak activity is expected to extend into next year,” Draghi said today at a press conference in Frankfurt after policy makers left the benchmark rate at a record low of 0.75 percent. “By the second part of the next year, we should see the beginning of a recovery” as global demand strengthens and the ECB’s low rates feed through to the economy, he said.
While Draghi’s pledge to buy government bonds has reduced borrowing costs in countries such as Spain and Italy and soothed concerns about the euro’s survival, the 17-nation currency bloc fell back into recession in the third quarter. The ECB’s latest forecasts paint a picture of economic stagnation and inflation falling well below its 2 percent limit. The euro dropped almost a cent to $1.2977 at 4:15 p.m. in Frankfurt.
The new projections “firmly support the case for lower interest rates,” said Howard Archer, chief European economist at IHS Global Insight in London. “The ECB appears to have the door open for an interest-rate cut, and we expect it to step through early in 2013.”
The ECB now forecasts the economy will shrink 0.5 percent this year, more than the 0.4 percent contraction it predicted in September. It cut its 2013 forecast to a contraction of 0.3 percent from 0.5 percent growth, and projected expansion of 1.2 percent in 2014. Risks to the outlook remain on “the downside,” Draghi said.
The central bank reduced its inflation forecast for 2013 to 1.6 percent from 1.9 percent, and predicted a rate of 1.4 percent for 2014.
Euribor futures contracts rose, signaling investors are adding to bets for lower borrowing costs. The implied yields on the contract expiring in December 2013 fell five basis points, or 0.05 percentage point, to 0.17 percent.
The Bank of England today left its key interest rate at 0.5 percent and refrained from expanding its asset-purchase program.
Draghi acknowledged that ECB policy makers considered a rate cut today, saying they had a “wide discussion.” Still, he said the outlook for medium-term price stability “hasn’t changed substantially” and highlighted “some positive aspects of the current situation,” such as an increase in German business confidence.
Much ‘Already Done’
He also indicated some resistance to taking the deposit rate, already at zero, into negative territory, saying officials discussed “the complexity that such a measure would involve and possible unintended consequences.”
“We will continue to look at the situation, but to some extent we have already done much,” Draghi said. “If you think from July to today, some countries’ spreads, or some sovereign bond yields, went down by 200 to 250 basis points. That’s much more than anything you can achieve by a reduction in the short-term policy rate.”
Italian and Spanish bond yields have plummeted since Draghi promised to do whatever it takes to save the euro and unveiled the unlimited bond-purchase program, known as Outright Monetary Transactions. Spain’s 10-year yield fell to 5.17 percent this week, more than 250 basis points below its 7.75 percent peak in late July, even though the ECB has yet to activate the tool.
Draghi today reiterated that the ECB stands ready to use the program if a country like Spain fulfills the prerequisites of seeking aid from Europe’s bailout fund and signing up to conditions. However, he said ECB intervention is not a foregone conclusion and it would “carry out its own independent assessment.”
Bundesbank President Jens Weidmann was the only member of the ECB’s Governing Council to vote against Draghi’s bond-purchase plan this year, saying it is tantamount to printing money to finance governments and warning of the risk that it could fuel inflation. German fears on price stability may make policy makers think twice about cutting rates again.
“A rate cut could further undermine support of inflation-averse Germans and thus be counterproductive,” said Christian Schulz, senior economist at Berenberg Bank in London. “It is pivotal for the ECB to ensure strong OMT credibility. This means ensuring a maximum of support from Germany.”
Nicholas Spiro, managing director of Spiro Sovereign Strategy Ltd. in London, said the ECB has been more successful in driving down Spanish and Italian bond yields than in propping up the economy.
“The fact that rates weren’t trimmed underscores the limited effect a further cut would have and how politically contentious further easing could be in German eyes,” he said. “The ECB remains firmly in a wait-and-see mode.”
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