ECB Leaves Rates On Hold as Investors Look to Draghi for QE Hint

ECB Leaves Interest Rates at Record Lows
  • ECB to revise economic forecasts at press conference Thursday
  • Draghi to address new risks, potential for more stimulus

The European Central Bank left interest rates at record lows, shifting the focus to President Mario Draghi’s press conference for clues on whether he sees a need to step up stimulus.

The 25-member Governing Council kept the main refinancing rate at 0.05 percent at its meeting in Frankfurt on Thursday, as predicted by all 47 economists in a Bloomberg News survey. The deposit rate and the marginal lending rate stayed at minus 0.2 percent, and 0.3 percent, respectively.

Six months after the ECB started a 1.1 trillion-euro ($1.2 trillion) quantitative-easing program, weaker commodity prices, a rout in global equities and China’s slowdown are stoking concerns it’ll struggle to revive consumer prices. With market-based measures of medium-term inflation falling, Draghi is likely to say the ECB has downgraded its economic forecasts, raising the question of whether more action is needed.

“I am expecting the language to be pretty open, fairly dovish,” Neil Williams, chief economist at Hermes Investment Group in London, said in a Bloomberg TV interview. “My concern has always been that he may well have to extend QE.”

Inflation Outlook

Draghi will speak to reporters at 2:30 p.m. in Frankfurt, where he’ll outline the September edition of the ECB’s quarterly staff predictions for economic growth and inflation. In June, forecasters said 2015 inflation should come in at 0.3 percent, rising to 1.5 percent in 2016 and 1.8 percent in 2017.

Those estimates assumed an average price for Brent crude this year of $63.80 a barrel, climbing to $71 a barrel next year. Oil slumped to less than $43 a barrel last month, suggesting the ECB’s price-growth forecasts for 2015 and 2016 are unlikely to survive intact.

While market-based inflation expectations -- as signaled by 5-year, 5-year forwards -- spiked as high as 1.73 percent this month, they’re down from 1.86 percent in July. Peter Praet, the ECB’s chief economist, said on Aug. 26 that global developments have “increased the downside risk of achieving the sustainable inflation path toward 2 percent.”

Output Gap

That alone may not be enough to justify stepping up QE. ECB Vice President Vitor Constancio has argued that price gains will return as long as the central bank can stimulate the economy and reduce slack. The June forecasts for growth saw the euro-area economy expanding by 1.5 percent this year, 1.9 percent next and 2 percent in 2017.

“Provided our policies are able to significantly reduce the output gap, we can rely on a material effect to help bring the inflation rate closer to target,” Constancio said at the U.S. Federal Reserve’s annual symposium in Jackson Hole, Wyoming, on Aug. 29. “A sustained recovery in inflation is conditional upon real activity and inflation expectations.”

The ECB, like other major central banks, has puzzled over the persistence of low inflation even as economic growth returns. Policy makers have said they’re ready to extend the duration of QE past the envisaged end-date of September 2016 if needed, which would increase the total amount of cash injected into the economy. Alternatively, they could expand the range of assets eligible for the purchase plan, which is currently limited to government or government-linked debt, asset-backed securities and covered bonds.

There is reason for optimism that China’s slowdown, its surprise currency devaluation and the market tumult won’t hit Europe’s growth outlook particularly hard, according to Anatoli Annenkov, euro-area economist at Societe Generale SA in London. That said, Draghi may want to get ahead of markets and announce a surprise easing of policy before Europe gets “stuck” with below-target inflation and weak growth, he said.

“It’s not our base case, but Draghi has surprised in the past and he’s very nimble and attentive to the markets,” Annenkov said. “The ECB thus needs to consider its options and whether to act pre-emptively.”

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