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Draghi as ECB Master of Suspense Keeps Investors on Edge

European Central Bank President Mario Draghi
European Central Bank President Mario Draghi is trying to guide the euro area through a fragile recovery and an extensive health check of the banking system while ensuring he still has the policy tools to react to any worsening of the economic outlook. Photographer: Ralph Orlowski/Bloomberg

Mario Draghi’s habit of springing surprises means that few can say what he’ll do when European Central Bank officials decide on monetary policy today.

Inflation at a four-year low and volatile market rates speak for further action by the Governing Council, even after it cut official rates to record lows in November. At the same time, signs of economic improvement and the central bank’s prediction that price gains will gradually return to target suggest the ECB president may prefer to hold fire. That’s the call by 62 of the 66 economists surveyed by Bloomberg News, while 4 predict a cut in the benchmark rate to 0.1 percent from 0.25 percent.

Expectations aren’t always a guide to the actions of Draghi, who has confounded investors with two rate cuts they didn’t see coming and unconventional efforts to keep the euro intact. With the currency bloc’s fragile recovery also threatened by turbulent global markets and the fallout from the U.S. Federal Reserve’s tapering, the chances are rising that he’ll announce another unprecedented measure.

“There is a powerful case for the central bank to do more, and there’s a high chance they will ease policy somehow,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “That may not be through a rate cut.”

Liquidity Absorption

Kounis joins economists from Goldman Sachs Group Inc. to Nomura International Plc who say Draghi may sidestep a rate cut by ending the sterilization of crisis-era bond purchases. Halting those operations, which soak up money created by the ECB’s now-terminated Securities Markets Program, would add about 175 billion euros ($237 billion) to the financial system.

The option has become more likely since Germany’s Bundesbank, a critic of the SMP, expressed support for ending the weekly absorption in the absence of inflation risks. Sterilization was put in place to assuage concern that the bond purchases would fuel price rises.

A halt would double the amount of excess liquidity, “have a strong impact on smoothing market volatility and put downward pressure on rates,” said Nick Matthews, senior economist at Nomura in London. “It would be a powerful signal that the ECB can do unsterilized bond purchases.”

The ECB will announce its interest-rate decision at 1:45 p.m. in Frankfurt and Draghi will hold a press conference 45 minutes later. The Bank of England will probably keep its benchmark rate at a record-low 0.5 percent at 12 p.m. in London, while its bond-purchase plan will stay at 375 billion pounds ($612 billion), according to separate Bloomberg surveys.

Surprise Cut

Draghi is trying to guide the euro area through a fragile recovery and an extensive health check of the banking system while ensuring he still has the policy tools to react to any worsening of the economic outlook.

Inflation unexpectedly slowed to 0.7 percent in the 18-nation bloc last month, less than half the ECB’s goal of just under 2 percent. The last time the figure was that weak was in October, when it dropped to the slowest since 2009 and contributed to a surprise November rate cut by the ECB.

Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London and one of three forecasters to correctly predict the November reduction, said prices are sufficiently weak for Draghi to back up his forward guidance that he will lower rates if needed.

Growth Signs

“Acting now would have the added virtue of anchoring expectations that the ECB will do whatever it takes within its mandate to avoid an ugly deflation scenario,” Barwell said. “We think that a non-standard -- less than 25 basis points -- cut in the main refinancing rate is more likely than not.”

RBS, Barclays Plc, BNP Paribas SA and Danske Bank A/S all forecast the ECB will cut its key rate by 15 basis points. Previous moves by the central bank have been multiples of a quarter percentage point.

Anders Svendsen, an economist at Nordea Bank Denmark A/S, said the weakness in January’s inflation isn’t enough to spur action given that other economic indicators point to an improving recovery and signs of stress in money markets have abated.

“We do not believe this data alone will be enough to prompt new easing,” he said. “The pressure stemming from money-market rates has subsided quite a bit” and “if anything, monetary conditions are less tight now.”

Studying Markets

Gauges of euro-area manufacturing and German business confidence are at the highest levels in 2 1/2 years. An ECB survey showed the region’s banks expect to stop tightening corporate credit standards this quarter, a move that could help rekindle lending.

Swings in interbank borrowing costs have eased. The interest rate that banks charge each other overnight fell to 0.13 percent on Feb. 4, the lowest level in a month. The rate, known as Eonia, surged as high as 0.36 percent on Jan. 20 and was above the ECB’s benchmark for four straight days in January, the longest run since 2011. It was at 0.15 percent yesterday.

Governing Council member Klaas Knot said in an interview with Bloomberg News published on Jan. 25 that policy makers are studying money-market movements and they should refrain from adding stimulus until they have a better understanding of its driving forces.

Other measures that may be discussed by policy makers include a negative deposit rate, more long-term loans to banks, and asset purchases. All of this comes against the backdrop of the ECB’s check on lenders’ balance sheets before it becomes the euro-area bank supervisor in November. The review may cause banks to rein in lending as they seek to avoid being identified as having insufficient capital.

Emerging Markets

External factors are also a risk, such as a slowdown in the developing economies that helped sustain euro-area exports. Emerging-market stocks had the worst start to a year since 2008. The euro has dropped 2 percent against the dollar this year.

Sentiment has soured as the Fed starts tapering its stimulus on the path toward an exit from ultra-loose monetary policy. That threatens to push up global market rates, undermining the ECB’s effort to keep borrowing costs low.

“Excitement has built” ahead of today’s ECB meeting, said Greg Fuzesi, an economist at JPMorgan Chase & Co. in London. “Some expect a move on rates, some expect a move on liquidity and some expect no move at all -- including us. It is a very close call.”

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