European Central Bank President Mario Draghi handed investors an early hint of what’s in store if inflation stays feeble in 2014.
Holding fire after last month’s surprise interest-rate cut, Draghi said policy makers yesterday briefly debated pushing their so-called deposit rate into negative territory and indicated any fresh long-term loans to banks would be tied to them passing along the money to companies and consumers.
“We are ready and able to act,” Draghi told reporters in Frankfurt after chairing the ECB’s final policy meeting of the year. “We are monitoring developments closely and are ready to consider all available instruments.”
The need to remain vigilant was underscored by new forecasts from the central bank, which showed inflation holding well under its target of just below 2 percent through 2015.
“The message here is don’t confuse inaction today for likely inaction tomorrow,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London.
The lack of immediate moves prompted European government bonds to fall yesterday, with the yield on the benchmark German 10-year bund yield rising to 1.87 percent, the highest in almost seven weeks.
The ECB yesterday predicted inflation of 1.1 percent in 2014 and 1.3 percent in 2015 as Draghi reiterated his pledge to keep borrowing costs low “for an extended period of time,” a month after lopping the key rate to a record low of 0.25 percent. Euro-area inflation was 0.9 percent in November.
Declaring that last month’s move had been “fully justified by this subdued outlook,” Draghi said the fear of a “prolonged period of low inflation” left officials on watch for further price-weakness even as the economy shows signs of stabilizing after emerging from a recession in the second quarter.
The 23-members of the ECB’s Governing Council briefly discussed reducing their deposit rate from zero and policy makers are technically able to do so, Draghi said. Charging banks for parking money would be aimed at forcing them to lend rather than leave excess cash in the ECB’s vaults overnight.
No major central bank has adopted such a policy, with one risk being that lenders find themselves unable to pass the cost onto their depositors, squeezing their profit margins and doing even more to deter them from lending.
Draghi said officials also want to ensure that any future offerings of long-term cash find their way into the economy, rather than being hoarded by banks. The bank last issued a Long Term Refinancing Operation in March 2012 and officials lament much of the cash they loaned then for three years went into funding governments or supporting bank balance sheets.
“If we are to do an operation similar to the LTRO, we’ll want to make sure that this is being used for the economy,” Draghi said. “And we want to make sure that this operation is not going to be used for subsidizing capital formation by the banking system.”
Such targeted lending is now very likely early next year as the maturity of existing three-year loans enters a final year, said Christian Schulz, an economist at Berenberg Bank in London. A negative deposit rate is less probable and Federal Reserve-style quantitative easing is not yet on the cards after Draghi questioned what assets would be bought, he said.
“The very subdued monetary and credit developments keep the ECB on alert,” said Schulz, a former ECB economist.
Since the ECB cut its key rate last month, data has shown that the euro area’s economic rebound came close to stalling in the third quarter, with growth of just 0.1 percent. The French economy unexpectedly shrank in the period and Italy extended its longest postwar recession.
The central bank said it now anticipates the economy will grow 1.1 percent next year and 1.5 percent in 2015 after shrinking 0.4 percent this year. According to the Organisation for Economic Cooperation and Development, the U.K. economy will expand 2.4 percent and 2.5 percent in those years, while the U.S. will grow 2.9 percent and 3.4 percent.
At Morgan Stanley, economist Elga Bartsch said such an environment leaves her expecting the ECB to cut its benchmark in the opening three months of 2014 with a high chance of the deposit rate also being trimmed.
Morgan Stanley has been one of the banks to warn the euro area faces the risk of following Japan into a deflationary lost decade.
Draghi rebutted such analysis, saying the ECB has been more proactive than Japan in easing monetary policy and dealing with troubled banks.
“I think that the situation in the euro area is quite different from what it was in Japan in the 90s and early 2000s,” Draghi said. “If you look at inflation expectations in the euro area, and the corresponding inflation rates, you would see that, in Japan, the inflation expectations were disanchored quite significantly and for a long period of time, which is not something we’re seeing today” in the euro area.