Mario Draghi’s beefed-up forward guidance is convincing economists he won’t raise interest rates any time soon.
Eighty percent of respondents in the Bloomberg Monthly Survey said the European Central Bank president’s promise to keep borrowing costs low for an extended period, introduced in July and reinforced twice this year, has been effective. The survey also showed 98 percent expect the ECB to keep its benchmark rate unchanged at a record low for a fifth month in April.
Draghi is trying to sustain a recovery from a debt crisis that almost splintered the euro area by guaranteeing monetary policy will stay loose, while leaving himself room to react to any future shocks. He “firmly reiterated” his rate pledge in January and said this month that spare capacity in the economy, known as the output gap, means rates will stay low until the revival is entrenched.
“The ECB’s policy makers have created some extra flexibility for themselves by including excess capacity in the forward guidance,” said Duncan de Vries, an economist at Nibc Bank NV in The Hague. “If they can continue to convince financial markets that the output gap is wide, maybe policy makers can succeed in keeping rates low for a little longer even in an improving economic environment.”
Of the 41 economists in the survey, 46 percent said the euro area’s economic outlook would improve over the next four weeks and 54 percent said it would remain little changed.
Draghi said on March 6, after policy makers left the main refinancing rate unchanged at 0.25 percent, that the economy is gradually recovering in line with the ECB’s baseline scenario. Gross domestic product increased more than economists expected at the end of 2013, a gauge of services and manufacturing output is at the highest level in 2 1/2 years, and economic optimism is increasing.
The premium that investors demand to hold Spanish 10-year bonds over German debt has fallen to about 1.7 percentage points from a euro-era high of more than 6 percentage points in July 2012, indicating that the crisis has eased. The spread between Italian and German 10-year debt has dropped to 1.8 percentage points from more than 5 percentage points over the same period.
Those data might normally boost expectations of an increase in the ECB’s rates, driving up market borrowing costs and derailing the recovery. Draghi said at his March monthly press conference for the first time that the “stock of slack that is weighing on the economy” will keep rates low “even after we see improvements” in the recovery. The message was repeated this week by Executive Board members Vitor Constancio, Sabine Lautenschlaeger and Peter Praet.
Board member Benoit Coeure said in Paris today that the ECB’s forward guidance “implies that real interest rates for borrowers will progressively fall as inflation rises. And we stand ready to act if this scenario does not materialize.”
Governing Council member Jens Weidmann, who heads Germany’s Bundesbank, told reporters in Frankfurt that while the ECB shouldn’t delay its exit from ultra-loose monetary policy, the current stance on rates is appropriate.
Policy makers are saying that as companies still aren’t producing close to their maximum rate, there’s some way to go before inflation would become problematic. The International Monetary Fund predicts that output in the euro area will be below capacity for a sixth year in 2014, at 2.5 percent of potential GDP, and the gap will only gradually narrow to 0.4 percent by 2018.
“In recent months we’ve seen that positive data and positive surprises have had less impact on money-market rate expectations,” said Elwin de Groot, an economist at Rabobank in Utrecht, the Netherlands. “This is evidence, in my view, that forward guidance has gained effectiveness.”
Overnight borrowing costs for euro-area banks were at 0.17 percent yesterday, little changed from a month earlier.
Policy makers have also reiterated that they’re willing to cut rates or take other easing measures if inflation is too weak. Consumer prices in the currency bloc climbed 0.8 percent in February from a year ago, less than half the ECB’s price-stability goal of just under 2 percent.
Governing Council member Klaas Knot, the head of the Dutch central bank, said in Amsterdam today that “if new shocks arise which push inflation further down to such a level we’re not comfortable with, then you would look at changing monetary conditions and then you’re looking at the classic lowering of interest rates.”
Three-quarters of the respondents in the survey said the ECB will look through weaker inflation if core consumer prices, excluding food and energy, hold steady or rise. Core inflation was 1 percent last month.
“Draghi has repeatedly argued that lower prices for food or energy augment purchasing power and therefore improve the economic outlook,” said Kristian Toedtmann, senior economist at Dekabank in Frankfurt. “He wouldn’t react at all as long as inflation expectations do not move downward.”