Jan. 10 (Bloomberg) -- The European Central Bank kept interest rates on hold as improving economic sentiment underpinned expectations of a gradual recovery this year.
Policy makers meeting in Frankfurt today left the benchmark rate at a record low of 0.75 percent, as predicted by 50 out of 55 economists in a Bloomberg News survey. The deposit and marginal lending rates were also unchanged at 0 percent and 1.5 percent, respectively. ECB President Mario Draghi will hold a press conference at 2:30 p.m. to explain the decision.
Improving confidence indicators have eased pressure on the ECB to reduce rates from a record low, a move fraught with the unknown consequences of possibly pushing the deposit rate below zero. A pledge last year to buy as many government bonds as it takes to stabilize the single currency, buttressed by political progress on bringing economies of the 17 member states closer together, has eased fears the bloc would splinter.
“Risks will always be there but there’s no reason to cut rates,” Marco Valli, chief euro-area economist at UniCredit Global Research in Milan, said before the decision. “Signs of economic stabilization are likely already in the first half of the year, thanks to the latest stabilization in financial markets. We’ll then see a modest recovery.”
Since the ECB’s policy meeting in December, the euro-area composite purchasing managers’ index, Germany’s Ifo business confidence gauge, France’s INSEE measure and Italy’s ISTAT indicator all showed improvement for a second month. The Banque de France said today that business confidence among manufacturing executives rose for the first time since August.
While negative data included a 1.4 percent drop in euro-area industrial production in October, the confidence reports lend credence to Draghi’s forecast for a “gradual recovery” in the second half of 2013.
Policy makers have shown a change of heart since a majority was open to a reduction in the cost of borrowing last month. Executive Board member Peter Praet said in an interview published Dec. 11 in the Wall Street Journal that the ECB has “little margin of maneuver” on rates and that they “aren’t the main issue.”
Elsewhere, the Bank of England kept its target for bond purchases at 375 billion pounds ($600 billion). The Monetary Policy Committee also left the benchmark interest rate at a record-low 0.5 percent.
Stuck in Recession
Even as the euro area’s forward-looking indicators stabilize, the 17-member currency area remains stuck in recession. While the economy needs more stimulus, the ECB doesn’t have many options left, said Nick Kounis, head of macro research at ABN Amro in Amsterdam.
If the outlook deteriorates, policy makers could lower the deposit rate below zero, effectively charging lenders to park cash with it. Because the ECB normally moves its three interest rates in tandem, a 25 basis-point benchmark cut might entail the deposit rate dropping to minus 0.25 percent.
“It seems to me they’re still quite cautious in taking that jump,” Kounis said. “That’ll probably leave the ECB on the sidelines in what is likely to be an excruciatingly slow recovery.”
The ECB still has the option of cutting the benchmark rate and leaving the deposit rate untouched, narrowing what is known as the “corridor” between the two rates. That could happen as soon as February or March, according to Juergen Michels, chief euro-area economist at Citigroup Inc. in London.
“The recent improvement in business sentiment readings is likely to run out of steam soon,” he said.
Athanasios Orphanides, a former ECB policy maker who left in May, said the lull in the crisis may prove illusory. He called for an interest-rate cut today because he sees the euro area facing the worst recession in its history.
“While there has been an improvement in the monetary conditions and government bond yields, I don’t subscribe to the optimistic view that the worst is behind us,” he said. It’s “totally unnecessary for policy makers to stand idly by when they could help.”
Political risks might threaten a euro-area recovery. In Italy, comedian-turned-politician Beppe Grillo is capitalizing on public anger against rising taxes and joblessness. Last month he released a 16-point platform calling for a referendum on euro membership. Citizens in Germany, Austria, Malta and Cyprus will also go to the polls this year.
“In the current climate, no German or Italian politician will preach what is necessary to get Europe growing again,” said Carsten Brzeski, an economist at ING Group in Brussels. “Draghi will probably have to start nudging them again.”
If the ECB president today reiterates his urging for progress on political and economic reform, he might reinforce that by signaling interest-rate cuts wouldn’t help much.
“It’s unlikely that they see any point in cutting rates either this month or any time soon,” said Tobias Blattner, an economist at Daiwa Capital Markets Europe in London. “The ball is now firmly back in the governments’ court.”
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