ECB May Soften Stance as Draghi’s Recovery Falters
Mario Draghi may have spoken too soon.
Since the European Central Bank President predicted an economic recovery at the start of the year, data have increasingly pointed to a deepening recession. While all 58 economists surveyed by Bloomberg say the ECB will leave its benchmark interest rate at a record low of 1 percent today, Draghi last week toned down his inflation-fighting rhetoric and sounded more cautious on the economic outlook, fueling speculation that he could ease monetary policy further.
“Things haven’t gone Draghi’s way,” said Kristian Toedtmann, senior economist at DekaBank in Frankfurt. “In contrast to a month ago, the ECB’s bias will now be more toward an easing than toward an exit strategy.”
Austerity measures aimed at taming the region’s sovereign debt crisis have pushed the Netherlands and Spain back into recession and prompted French voters to revolt against President Nicolas Sarkozy with an election looming on May 6. The ECB, which has already pumped more than 1 trillion euros ($1.3 trillion) of emergency cash into the banking system, may be reluctant to add to stimulus as it presses governments to take responsibility for the crisis.
Policy makers meeting in Barcelona today will announce their rate decision at 1:45 p.m. and Draghi holds a press conference 45 minutes later. Officials hold two policy meetings a year away from their Frankfurt headquarters.
In the first three months of this year, Draghi said survey data showed a “tentative stabilization” of economic activity at low levels and, while noting the outlook was subject to downside risks, predicted a gradual recovery.
With the ECB’s three-year loans to banks helping to calm financial markets, Draghi also told Germany’s Bild Zeitung in March that “the worst is over.”
Survey indicators are now telling a different story.
After rising mildly in January and February, a gauge of euro-area manufacturing plunged in April to the lowest in almost three years, according to London-based Markit Economics. The index, based on a poll of purchasing managers, shows that manufacturing activity has contracted for nine straight months.
A report yesterday showed euro-area unemployment rose to a 15-year high of 10.9 percent in March, and an economic confidence indicator published by the European Commission fell last month to the lowest level since December.
‘What Will It Take?’
“What will it take for the ECB to cut interest rates?” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London. If it doesn’t act today, “it will be important to see whether Draghi prepares the markets for a June move,” he said.
The ECB is due to issue new projections next month. In March, it revised down its 2012 economic outlook to a contraction of 0.1 percent from an expansion of 0.3 percent. The central bank also raised its 2012 inflation forecast to 2.4 percent from 2 percent and started to warn of “upside risks” to price stability, indicating policy makers didn’t intend to ease policy further.
Draghi changed his stance last week.
Delivering a policy statement to lawmakers in Brussels on April 25, he dropped any mention of upside inflation risks, omitted reference to an economic recovery and called on politicians to agree on a “growth compact.”
Since then, Eonia forward contracts have retreated, signaling investors are increasing bets on rate cuts.
“The ECB has to accept that the recession will be longer and deeper than forecast only two months ago,” said Jens Sondergaard, senior European economist at Nomura International Plc in London. “The key question is: Has the economic outlook deteriorated sufficiently to take rates to a record low or do they want to see more data?”
Adding to the dilemma are growing divergences between euro- area economies and concerns within the ECB’s 23-member Governing Council that more stimulus would take pressure off governments to make necessary fiscal reforms.
“Monetary policy is not a panacea and central bank firepower is not unlimited, especially not in a monetary union,” Bundesbank President Jens Weidmann said on April 23. “We can only win back confidence if we bring down excessive deficits and boost competitiveness. And it is precisely because these things are unpopular that makes it so tempting for politicians to rely instead on monetary accommodation.”
In Germany, Europe’s largest economy, business confidence is at a nine-month high, unemployment is at a two-decade low of 6.8 percent, and workers are winning some of the biggest wage increases since reunification in 1990. By contrast, unemployment in Spain is at 24.4 percent and the economy has entered its second recession since 2009.
Investor concern over Spain’s ability to reduce its budget shortfall has increased since Prime Minister Mariano Rajoy announced in March that the country will miss a 2012 deficit goal set by the European Union. That pushed Spanish 10-year yields above 6 percent last month and propelled the cost of insuring the country’s bonds against default to a record.
“Given that we expect the peripheral situation to continue deteriorating in a significant way over the coming months, we expect the ECB to come under increasing pressure as to how it will respond to renewed stress in the system,” said Nick Matthews, senior European economist at Royal Bank of Scotland Plc in London, who forecasts cuts in the benchmark rate in June and September.
The ECB has shelved its government-bond purchase program and hinted it doesn’t want to offer banks another round of three-year loans. A cut in the benchmark rate would take it into uncharted territory below 1 percent, and raise the issue of whether to take the 0.25 percent deposit rate to zero.
Even though “the latest indicators were negative,” we “have not changed our baseline scenario as of this moment,” ECB Vice President Vitor Constancio told reporters in Frankfurt on April 26. “We have to wait to see what happens in the next few months to conclude if our baseline scenario is really in danger or not.”
Michael Schubert, an economist at Commerzbank AG in Frankfurt, said policy makers aren’t about to announce additional stimulus measures, “at least not in the short term.”
“While the ECB will continue to keep its options open, it still believes it is up to the governments to take action,” he said.
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