Aug. 7 (Bloomberg) -- The crisis in eastern Europe is showing signs of disrupting Mario Draghi’s economic outlook.
Evidence is building that the conflict in Ukraine and European Union sanctions against Vladimir Putin’s Russia are undermining a euro-area recovery that the European Central Bank president already describes as weak. With the ECB expected to keep interest rates on hold near zero today and refrain from any new policy measures, Draghi is likely to face questions on how he plans to keep the economy on track.
The ECB may have few tools left to mitigate the impact of political turmoil that European companies from Anheuser-Busch InBev NV to Siemens AG say is hurting their business. A volley of measures introduced in June will take time to work, and policy makers have so far shied away from wheeling out a full-scale asset-purchase program.
“The euro-zone recovery is very fragile and the macro situation fluid,” said Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich. “Expect Draghi to elaborate on spillover risks from the Russia-Ukraine crisis.”
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. All 57 economists in a Bloomberg survey say officials will keep the benchmark rate at 0.15 percent.
The Bank of England’s Monetary Policy Committee is also predicted to leave its key interest rate unchanged, at a record-low 0.5 percent, when it meets at noon in London.
The meetings come against the backdrop of a mounting political crisis. Russia has massed troops along its border with Ukraine, prompting the U.S. to say there’s a risk of an invasion. President Putin retaliated yesterday against EU and U.S. sanctions by ordering restrictions on food imports from countries that seek to punish Russia.
The tension has hit investment and trade. European stocks closed yesterday at their lowest level in almost four months and the euro at one point dropped to its weakest against the dollar since November. The single currency traded at $1.3375 at 10:53 a.m. Frankfurt time today.
Belgium’s AB InBev, the world’s biggest brewer, said beer sales in Ukraine plunged more than 20 percent in the second quarter. At Germany’s Siemens, Europe’s largest engineering company, Chief Executive Officer Joe Kaeser said geopolitical strife poses a “serious risk for Europe’s growth in the second half.”
Those headwinds aren’t making Draghi’s job any easier. Euro-area inflation is already running at less than a quarter of the ECB’s goal and recent data suggest that growth is struggling to gain momentum.
Italy, the currency bloc’s third-largest economy, unexpectedly slipped back into recession last quarter. Factory orders in Germany, the largest economy, dropped in June by the most since 2011, with the Economy Ministry citing geopolitical tensions as damping the outlook for coming months.
Euro-area consumer prices rose 0.4 percent last month from a year earlier, the slowest pace in almost five years. That compares with an ECB goal of just under 2 percent.
“Downside risks to growth and inflation appear to be on the rise,” said Anatoli Annenkov, an economist at Societe Generale SA in London. “The low inflation number for July and rising geopolitical tensions make this point clear, and highlights the severe risk of ‘lowflation’ in the euro area.”
One question Draghi will likely face today is what he can do in response. The ECB president has said that an external shock that derails the baseline scenario of a gradual recovery in prices would require broad-based asset purchases, or quantitative easing. Getting policy makers to agree on what constitutes a shock may not be easy.
Governing Council member Ewald Nowotny said in an interview on July 10 that he doesn’t see any need for further action in the near future. Fellow council member Ardo Hansson told Bloomberg News on July 16 that there’s no immediate need for large-scale bond purchases. He also said a smaller program to buy asset-backed securities won’t be ready any time soon.
“Unless something really unexpected happens that puts us on a different inflation projectory, then the idea of doing something more at this stage shouldn’t be part of our baseline assumption,” Hansson said.
One reason not to jump in with additional steps now is that the barrage of new measures announced in June will take time to feed through to the real economy. The tools include a new targeted lending plan for banks that only starts disbursing cash in September.
The euro area may also be better able to absorb shocks than during the depths of the financial crisis. The collapse and government bailout of Banco Espirito Santo SA, once Portugal’s biggest lender by market value, hasn’t prevented euro-area bond yields from holding near record lows. The yield on German two-year bonds fell below zero today for the first time since May 2013.
Manufacturing and services activity in the euro area measured by Markit Economics strengthened in July and the reading has been above 50, indicating expansion, for a year. A gauge of economic confidence for the region unexpectedly rose.
“It is undoubtedly true that downside risks going forward have been mounting recently due to geopolitical tensions,” said Andreas Rees, chief Germany economist at UniCredit MIB in Frankfurt. “Psychological burdens have increased recently. However, it is too early to call it a day.”
The next clue on the region’s inflation outlook will come on Aug. 14, when the ECB publishes its quarterly Survey of Professional Forecasters. In September, the ECB will probably revise its own inflation forecasts lower, according to Marchel Alexandrovich, an economist at Jefferies International Ltd. in London.
Even then, the central bank “will likely take some time before it considers further policy moves,” he said. “The ECB is in a holding pattern -– watching the data and, increasingly, political developments surrounding Russia.”
The ECB predicted in June that inflation will average 0.7 percent this year, with the rate accelerating to 1.4 percent in 2016.
“Putin’s behavior over the next few weeks is the key tail risk to watch,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The biggest risk to the recovery is the confidence shock which an open Russian invasion of Ukraine could cause across core Europe and beyond.”
To contact the editors responsible for this story: Craig Stirling at email@example.com Paul Gordon, Zoe Schneeweiss