ECB Keeps Interest Rates on Hold as Deflation Risk Fades

Mario Draghi
ECB President Mario Draghi. Photographer: Martin Leissl/Bloomberg

The European Central Bank kept interest rates on hold at record lows as data signaled that the risk of deflation in the euro area is waning.

The Governing Council, meeting in Frankfurt, maintained the benchmark rate at 0.05 percent. The deposit rate and the marginal lending rate stayed at minus 0.2 percent and 0.3 percent, respectively. ECB President Mario Draghi will explain the decision at 2:30 p.m., when he’s also due to present fresh economic forecasts for the currency bloc.

With euro-area inflation turning positive in May for the first time in six months, Draghi may express optimism that the 19-nation region is on the road to recovery, even as turmoil in Greece comes to a head and unemployment remains above 11 percent. The improved outlook could prompt questions over the extent to which the ECB will stick to plans to buy 60 billion euros ($67 billion) of securities a month through September 2016.

“The emphasis will remain on the Governing Council’s intention to firmly and fully implement all existing monetary policy measures,” said Nick Matthews, senior European economist at Nomura International Plc in London. “Market-based inflation expectations remain well below the historical norm.”

Greece Proposal

Greece remains a wild card as time runs short to agree on the terms under which it can access bailout funds. Draghi sat down in Berlin on Monday night with German Chancellor Angela Merkel and other representatives of the Greece’s creditors to agree on what it must do to avoid a default that could splinter the currency bloc.

Greek Prime Minister Alexis Tsipras will be told the details of that proposal on Wednesday and is scheduled to meet European Commission President Jean-Claude Juncker in Brussels.

In the meantime, depositors have been fleeing Greek lenders, which are being kept afloat by Emergency Liquidity Assistance from the nation’s central bank with the approval of the ECB.

The Governing Council raised the cap on ELA by 500 million euros to 80.7 billion euros on Tuesday. Policy makers avoided tightening the collateral requirements for the funding. A deeper discount -- or haircut -- on Greek securities pledged as collateral would reflect the rising probability of a government default.

The ECB kept interest rates on hold at record lows as data signaled that the risk of deflation in the euro area is waning.
The ECB kept interest rates on hold at record lows as data signaled that the risk of deflation in the euro area is waning.
Photographer: Martin Leissl/Bloomberg

New Projections

Better news for the ECB lies in consumer prices, which are signaling the deflation scare that helped usher in QE is on the wane. The inflation rate rose to 0.3 percent in May, beating economists’ forecasts. Core inflation, which strips out typically volatile energy and food prices, was 0.9 percent, the fastest in nine months.

Those data will buttress the Eurosystem’s new staff forecasts for growth and inflation. In March, the ECB predicted gross domestic product will rise 1.5 percent this year and 1.9 percent in 2016. Inflation was seen accelerating from zero in 2015 to 1.5 percent next year.

Unemployment data published on Wednesday also offered cautious reason for optimism. Euro-area joblessness fell more than estimated to 11.1 percent in April. Italian unemployment slid to 12.4 percent from 13.0 percent.

The Organization for Economic Cooperation and Development said in a report also released Wednesday that the currency bloc is the “bright picture” in a faltering global economy. The OECD cut its 2015 world growth forecast to 3.1 percent from 3.7 percent, saying investment is lagging and risks such as a Greek default are hurting confidence.

Full Implementation

Even so, the ECB remains far short of its inflation goal of just under 2 percent and the recovery remains fragile. A purchasing managers index published by Markit Economics on Wednesday showed services growth slowed in May. Draghi has warned of downside risks and said the institution’s forecasts are contingent on the full implementation of quantitative easing.

“The upside for growth in a number of euro-zone countries continues to be limited by relatively poor competitiveness amid ongoing significant structural problems,” said Howard Archer, chief U.K. and European economist at IHS Global Insight in London. “Events in Greece could weigh down on euro-zone sentiment and growth if there is a default or even ultimate exit.”

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