ECB Holds Rates as Stronger Euro Threatens Economic Recovery

The European Central Bank left interest rates unchanged even as a stronger currency threatens the euro area’s recovery from recession.

Policy makers meeting in Frankfurt today kept the benchmark rate at a record low of 0.75 percent, as forecast by all 60 economists in a Bloomberg News survey. President Mario Draghi holds a press conference at 2:30 p.m. to explain the decision.

Recent indicators suggest the euro-area economy may return to growth later this year, easing pressure on the ECB to lower rates further. At the same time, a rising euro could hurt exports and stymie the recovery before it has begun, and looser monetary policy in the U.S. and Japan may continue to weaken the dollar and the yen.

“The euro is a little bit too strong,” Bernard Charles, Chief Executive Officer at the French software maker Dassault Systemes SA, said in an interview with Bloomberg Television today. This will “have an effect this year” on the economy and its “capacity to export,” he said.

The common currency rose 0.3 percent to $1.3568 today. It reached a 14-month high against the dollar this month and a three-year high against the yen. It has climbed 11 percent on a trade-weighted basis since Draghi pledged on July 26 to do whatever is needed to preserve Europe’s monetary union.

Bank of England

The Bank of England kept its target for bond purchases at 375 billion pounds ($589 billion) and left the key rate at a record low of 0.5 percent.

Draghi may face questions today about Italy’s Banca Monte dei Paschi di Siena SpA, which is engulfed in criminal probes over its use of derivatives to hide losses. Draghi has yet to publicly comment on his role in overseeing Monte Paschi, the world’s oldest bank, when he was governor of the Bank of Italy.

Still, the focus is likely to be on the euro, which hit $1.3711 on Feb. 1, the highest since November 2011.

A stronger currency damps inflation by reducing prices on imports and poses a threat to growth by increasing the cost of exports. Stora Enso Oyj, Europe’s biggest papermaker, said this week exchange rates had a negative impact on 2012 sales.

“Markets will want to hear stronger words on the foreign-exchange front to stop the upward trend currently in place,” said Nick Matthews, senior euro-area economist at Nomura International Plc in London. “But we doubt this will happen. Draghi is likely to reaffirm last month’s position” that the exchange rate is not a policy target for the ECB, he said.

Important Element

While Draghi’s predecessor, Jean-Claude Trichet, was willing to intervene verbally to influence the euro, speaking of “brutal” shifts in currencies, Draghi has been circumspect so far.

“I never comment on exchange rates,” he said on Jan. 10, while acknowledging that currencies are “certainly a very important element as far as growth and price stability are concerned.”

The ECB estimates the euro-area economy will shrink 0.3 percent this year before posting growth of 1.2 percent in 2014. Draghi spurred hopes of an economic recovery later this year when he spoke of “positive contagion” on financial markets in January.

He may paint a less upbeat picture today.

“We expect the tone of the statement to turn more cautious on the economic outlook and more relaxed on the outlook for inflation, reflecting the recent increase in some money-market rates and the appreciation of the euro,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London.

Loan Repayment

The Euro Overnight Index Average, or EONIA, climbed to 0.08 percent from 0.06 percent after banks handed back more of the ECB’s three-year loans than economists forecast at the first early-repayment opportunity last month.

As a result of the repayments, the ECB’s balance sheet shrank to an 11-month low of 2.77 trillion euros ($3.76 trillion) last week from a record-high of 3.1 trillion euros at the end of June.

That contrasts with the Fed’s growing balance sheet, which rose above $3 trillion for the first time in January after Chairman Ben S. Bernanke committed to open-ended purchases of Treasuries and mortgage-backed securities to combat unemployment. The Bank of Japan is also expanding its stimulus to fight deflation.

‘Currency War’

“A significant shift is underway in global central banking,” said Paul Mortimer-Lee, global head of market economics at BNP Paribas SA in London. “There is a worldwide currency war and the ECB seems to be a central bank that is not targeting the real economy as much as the Fed, the Bank of Japan and the Bank of England,” he said. The ECB “risks being the loser.”

A 10 percent appreciation against a basket of trading partners reduces euro-area gross domestic product by 0.5 percentage point in the first year, according to Elga Bartsch, chief European economist at Morgan Stanley & Co. in London.

The euro’s strength may force the ECB to revise down its economic projections in March, “reopening the door for another rate cut,” said Carsten Brzeski, an economist at ING Group in Brussels. Twelve of 42 economists in another Bloomberg survey forecast an ECB rate reduction in the second quarter.

Still, euro-area economic confidence is at a seven-month high and Germany, the region’s largest economy, is showing signs of recovery.

“The ECB is in a difficult position,” Brzeski said. “A rate cut now would probably do little to reverse the current trend of the exchange rate. Draghi will have to use verbal intervention to limit any further appreciation of the euro without committing the ECB to possible future policy action.”