ECB Keeps Interest Rates on Hold Amid Improving Economy
Policy makers meeting in Frankfurt today left the main refinancing rate at 0.5 percent for a third month after reducing it by a quarter point in May. The decision was predicted by 62 of 63 economists in a Bloomberg News survey, with Wells Fargo Securities the only institution to forecast a cut. ECB President Mario Draghi will hold a press conference at 2:30 p.m.
The task for Draghi will be to foster growth while assuring financial markets that the ECB won’t tighten monetary policy too soon. Euro-area manufacturing unexpectedly expanded in July for the first time in two years and business confidence improved a third month. At the same time, lending to companies and households across the 17-nation currency bloc fell the most on record in June.
“While the survey data have continued to remain consistent with the ECB’s recovery scenario, we expect Draghi to reaffirm that the risks to the economic outlook remain to the downside,” said Nick Matthews, senior European economist at Nomura International Plc in London. “He will stress a dovish tone.”
The ECB held its deposit rate at zero and its marginal lending rate at 1 percent. The Bank of England kept its bond-purchase target at 375 billion pounds ($571 billion) and maintained its key rate at 0.5 percent today. The Federal Reserve said yesterday that persistently low inflation could hamper the economic expansion and pledged to keep buying $85 billion in bonds every month.
Draghi made an unprecedented commitment at the ECB’s July 4 meeting to keep interest rates low for an extended period, without specifying a time frame, saying it would support a recovery in economic activity later in the year.
The European Commission’s gauge of economic confidence in the euro area climbed to the highest level in 15 months in July. An index of manufacturing published today increased to 50.3, higher than the estimate of 50.1 by London-based Markit economics on July 24. A reading above 50 signals growth.
Countries in both the core and the periphery of the currency bloc have shown signs of improvement. Germany, Europe’s largest economy, saw business confidence increase for a third month and unemployment hold near a two-decade low in July. Spain’s contraction slowed to 0.1 percent in the second quarter from 0.5 percent in the first. The euro region shrank in the six quarters ended March.
“The recent data in the euro area has been rather good,” said Christoph Kind, head of asset allocation at Frankfurt Trust in Frankfurt. “You could in principle say that the recession is over. The ECB could argue that the data are proof that the expansive monetary policy is bearing fruit, but it’s by no means the time to change their guidance.”
One sign that the euro-area recovery has a long way to go is unemployment, which held at a record 12.1 percent in June, according to data from the European Union’s statistics office in Luxembourg yesterday. Spain had the highest rate at 26.3 percent, while the region’s youth unemployment rose to 23.9 percent.
The recession is also still dragging on credit. Bank lending to private-sector companies and households shrank 1.6 percent in June from a year earlier, the most since the euro was founded in 1999, as companies in countries such as Spain and Greece struggled to get affordable funding. Draghi last month cited “weaker and weaker” credit flows as one reason for keeping interest rates low.
“Credit tends to follow the economic cycle, not lead it,” said Christian Schulz, senior economist at Berenberg Bank in London. “In the initial stages of the recovery, households and companies use their cash reserves to fund spending and investment before lending takes off again.”
With economic growth still not guaranteed, some investors are looking for more explicit forward guidance. It may be too early for Draghi to include dates or economic targets for ending the bank’s accommodative monetary policy, according to Nick Kounis, head of macro research at ABN Amro NV in Amsterdam.
“Right now it’s being used to make sure that there isn’t an exit priced in in the foreseeable future,” he said. “Draghi wants to keep short-term rates anchored, even as the economy improves.”
The ECB’s six-man Executive Board is increasingly open to releasing the minutes of Governing Council meetings. Benoit Coeure and Joerg Asmussen voiced support for publication on July 29. Draghi backed the idea in comments in Germany’s Sueddeutsche Zeitung yesterday. Governing Council member Jens Weidmann, who heads the Bundesbank, said he would welcome a timely release of transcripts to make the ECB’s decisions more comprehensible, Handelsblatt reported today.
Governing Council member Ewald Nowotny, the head of Austria’s central bank, said last year he is wary of publication soon after the meetings as it may prompt governors to act more in their own national interest. He stands by that view, Wiener Zeitung reported yesterday.
Publishing the minutes could be “one element of a broader set of reforms which would be designed to educate the market about the policy debate within the council and reduce the hyperactive response to every utterance,” said Richard Barwell, senior European economist at Royal Bank of Scotland Plc in London. “Minutes could therefore complement the guidance in pursuit of stable money market rates.”
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