Draghi Fuels Bets on Rate Cut With Risk of Limited ImpactJeff Black and Jana Randow
Mario Draghi has stoked expectations that officials will deliver an interest-rate cut today even as they doubt its impact.
The European Central Bank President said on April 4 he stands ready to act if Europe’s economic outlook worsens. After a month in which inflation plunged, economic confidence slumped and unemployment rose, 44 out of 70 economists in a Bloomberg News survey now predict the ECB will cut its benchmark rate by a quarter-point today to a record low of 0.5 percent.
With transmission of the ECB’s rates still hampered by the region’s debt crisis, the risk is that such a move will fail to revive the economy and take the central bank closer to exhausting its current armory. Draghi himself has voiced doubts about the effectiveness of further interest-rate cuts and board member Joerg Asmussen said last week there are limits to what the ECB can do.
“Data released since the April rate-setting meeting have provided further evidence that more monetary action could be needed in the euro zone,” said Carsten Brzeski, senior economist at ING Belgium SA in Brussels. “But as long as the transmission mechanism is not working, a rate cut could simply go up in smoke.”
The ECB decision is due at 1:45 p.m. in Bratislava, where the Governing Council is meeting this month. Draghi holds a press conference in the Slovakian capital 45 minutes later.
Limits of Policy
Faced with a struggling economy and limits on the potency of conventional means to stimulate it, the ECB could also consider options including long-term loans, corporate-bond purchases and forward guidance on interest rates. In the past, policy makers have found arguments against most of them.
Last month, the Governing Council tasked technical committees at the central bank to investigate ways to stimulate lending to small- and medium-sized businesses, which provide about half of all jobs in Italy and Spain. That plan may involve other institutions such as the European Investment Bank or the European Commission, Draghi said on April 4.
Financial markets have focused expectations on a drop in the cost of borrowing. Spanish government bonds extended an eight-month gain, the cost of insuring against default on European corporate debt fell, and European stocks posted the biggest increase in five months last week on expectations that the ECB would ease monetary policy -- five months after the prospect of a rate cut emerged.
Expectations for a reduction in borrowing costs and speculation the U.S. Federal Reserve would affirm its commitment to bond purchases helped push the euro to a two-month high of $1.3243 yesterday. The Fed yesterday pledged to keep buying bonds at a pace of $85 billion a month and said it’s ready to raise or lower that level as economic conditions evolve.
“The pressure is building and the ECB needs to do something,” said Nick Matthews, senior European economist at Nomura International Plc in London. “If they don’t cut rates, the market will be disappointed.”
Since Draghi said the ECB stands “ready to act” in the face of worsening data, inflation slowed to 1.2 percent in April, the lowest level since February 2010 and well below the ECB’s 2 percent price-stability threshold.
Economic confidence as measured by the European Commission dropped to its lowest level since December, suggesting business executives and consumers doubt that Draghi’s predicted recovery this year will actually materialize. On top of that, unemployment in the 17-member euro area rose to a fresh record of 12.1 percent in March and manufacturing output contracted for a 21st month in April.
“So far we haven’t seen any improvement in the situation,” Draghi said at a press conference in Washington on April 19.
“The central arguments for a rate cut are the persistently weak economic confidence indicators that don’t point to a rapid recovery, and the increasing danger of undesirably low inflation rates,” said Kristian Toedtmann, senior economist at DekaBank in Frankfurt. “We see an interest-rate move as more than just a cosmetic maneuver, in that it would keep long-term money-market rates low or even lower them further.”
Still, with economies like Spain and Italy stuck in recession and their banking systems wary of taking on more risk, a cut in ECB rates may not automatically pass through to companies and households wanting to invest.
“The ECB has continuously stated that fixing monetary transmission will be much more effective than cutting interest rates from the current levels and is key to supporting a recovery in the periphery,” said Anders Svendsen, an economist at Nordea Bank Denmark A/S in Copenhagen. “To the ECB, fixing monetary transmission is done with the use of non-standard measures.”
Asmussen said last week that the effect of any further rate reductions may only be “limited” because they are not being passed on in the economies that need them most. He also said that the ECB still can’t emulate the policies of the Bank of England, the Bank of Japan and the Fed.
“Large-scale asset purchase programs targeted at capital markets would not be very helpful in the euro area” and policies like forward guidance or quantitative easing “are not easily applicable here,” he said in a speech in London on April 25. One day later, he told a Frankfurt audience that higher inflation or targeting the rate of unemployment “are ideas that we simply cannot entertain.”
That leaves policy makers with few options when they convene in Bratislava today, and an interest-rate cut might be the compromise all 23 officials can agree on.
“If you have inflation closer to 1 percent than to 2 percent and an economy in recession without signs of upward momentum, doing as much as you can on the conventional side is justified,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “A 25 basis-point cut even in the best of times isn’t going to set the world on fire, but it’s better than nothing. Obviously, the bigger impact would be created by something a little bit more outside the box.”