Draghi Spared as Confidence Swing Quells Rate-Cut TalkJeff Black and Gabi Thesing
Mario Draghi might be spared from having to make the thorniest of interest-rate cuts.
Improving confidence indicators have eased pressure on the European Central Bank president to reduce the benchmark rate from a record low, a move fraught with the unknown consequences of possibly pushing the deposit rate below zero. While officials discussed a cut in borrowing costs last month, only five out of 55 economists in a Bloomberg survey predict that outcome today. The rest see the benchmark staying at a record-low 0.75 percent.
ECB policy makers will begin their first meeting of the year in Frankfurt with the euro-area debt crisis showing signs of waning. A pledge last year to buy as many government bonds as it takes to stabilize the single currency, buttressed by political progress on bringing economies of the 17 member states closer together, has eased fears the bloc would fall apart.
“The economy does not scream rate cut right now,” said James Nixon, chief European economist at Societe Generale SA in London. “Draghi’s medicine is working, the economic outlook has improved, the economy has bottomed out, so why would you cut?”
Since the ECB’s December decision, the euro-area composite purchasing managers’ index, Germany’s Ifo business confidence gauge, France’s INSEE measure and Italy’s ISTAT indicator all showed improvement for a second month. While negative data included a 1.4 percent drop in euro-area industrial production in October, the confidence reports lend credence to Draghi’s forecast for a “gradual recovery” in the second half of 2013.
The ECB will announce the interest rate decision at 1:45 pm in Frankfurt, and Draghi will explain the decision in a news conference 45 minutes later.
“Leading indicators in the euro zone have bottomed and some even show tentative signs of improvement,” said Ken Wattret, chief euro-area economist at BNP Paribas in London. That “would suggest a ’no change’ outcome” today.
The Banque de France said today that business confidence among manufacturing executives rose the first time since August. French November manufacturing production also rose, the statistics office said.
Change of Heart
Financial markets have improved too. The Stoxx Europe 600 Index yesterday reached the highest in more than 22 months and Spain’s 10-year bond yield today fell below 5 percent for the first time since March 9 after the nation sold more securities than planned at its first debt auction this year. That’s down from a euro-era record of 7.75 percent after Draghi’s July 26 pledge to do “whatever it takes” to defend the euro.
Policy makers have shown a change of heart since a majority was open to a reduction in the cost of borrowing last month. Executive Board member Peter Praet said in an interview published Dec. 11 in the Wall Street Journal that the ECB has “little margin of maneuver” on rates and that they “aren’t the main issue.”
Elsewhere, the Bank of England will keep its target for bond purchases at 375 billion pounds ($600 billion), according to all 39 economists in a Bloomberg News survey. The Monetary Policy Committee will also leave the benchmark interest rate at a record-low 0.5 percent, according to a separate poll.
As the ECB’s key rate for borrowing has fallen towards zero during the financial crisis, so the prospect of the central bank charging lenders to park cash with it has arisen. Because the ECB normally moves its three interest rates in tandem, a 25 basis-point benchmark cut might entail the deposit rate dropping to minus 0.25 percent.
“It looks like the ECB board have examined the idea and decided to play it down,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc in London. “It could do irreparable damage to the money-market fund industry, it may not get fully passed through to the economy, and anyway, one cut would have very little effect.”
The euro area remains stuck in recession, and the ECB’s own projections suggest the economy needs more stimulus from the central bank, according to Elga Bartsch, chief European economist at Morgan Stanley & Co. in London.
Unemployment in Europe reached a record 11.8 percent in November, with at least every second young Spaniard out of work. The ECB last month predicted the 17-nation economy will shrink 0.3 percent this year instead of a forecast for 0.5 percent growth. The outlook shows inflation will average 1.6 percent, dropping to 1.4 percent in 2014 -- well below the ECB’s 2 percent price stability ceiling.
“It’s pretty incomprehensible that the ECB didn’t cut rates last month,” said Bartsch, who expects a 25 basis-point reduction today. “It will help banks that have borrowed from the ECB, and it’s important that the ECB breaks through the zero-boundary in light of the inflation outlook.”
The central bank has the option of cutting the benchmark rate and leaving the deposit rate untouched, narrowing what is known as the “corridor” between the two rates. That could happen as soon as February or March, according to Juergen Michels, chief euro-area economist at Citigroup Inc. in London.
“The recent improvement in business sentiment readings is likely to run out of steam soon,” he said.
Athanasios Orphanides, a former ECB policy maker who left in May, said the lull in the crisis may also prove illusory.
“While there has been an improvement in the monetary conditions and government bond yields, I don’t subscribe to the optimistic view that the worst is behind us,” he said. “None of the fundamental issues have been addressed.”
Political risks might threaten a euro-area recovery. In Italy, comedian-turned-politician Beppe Grillo is capitalizing on public anger against rising taxes and joblessness. Last month he released a 16-point platform calling for a referendum on euro membership. Citizens in Germany, Austria, Malta and Cyprus will also go to the polls this year.
“In the current climate, no German or Italian politician will preach what is necessary to get Europe growing again,” said Carsten Brzeski, an economist at ING Group in Brussels. “Draghi will probably have to start nudging them again.”
If the ECB president today reiterates his urging for progress on political and economic reform, he might reinforce that by signaling interest-rate cuts wouldn’t help much.
“It’s unlikely that they see any point in cutting rates either this month or any time soon,” said Tobias Blattner, an economist at Daiwa Capital Markets Europe in London. “The ball is now firmly back in the governments’ court.”