ECB Urgency Fades as Draghi Savors Euro-Area Sentiment Boost

Mario Draghi will probably reassure investors today that the longest recession in the euro region’s history isn’t enough to justify another interest rate cut and a recovery will emerge later this year, economists said.

One month after reducing borrowing costs to a record low, the European Central Bank president will probably emphasize improving sentiment among investors, entrepreneurs and consumers even if officials need to cut their economic outlook for the year as a whole, according to economists at Nordea Bank AB and Nomura International Plc.

“The expected modest recovery in the second half of this year is likely to remain in place,” said Anders Svendsen, an economist at Nordea in Copenhagen. “Sentiment remains fairly solid and key figures have improved. The sense of urgency that had built up ahead of last month’s meeting is replaced by a sense of calm this time.”

In May, Draghi left investors to ponder a menu of further measures that the ECB might consider to aid economic growth, including another rate reduction and charging banks to hold deposits at the central bank. Since then, officials have sought to damp expectations of imminent action, even after data showed the euro region’s recession extended in the first quarter and Germany’s economy barely grew.

The ECB will keep its benchmark interest rate unchanged at 0.5 percent today, according to 57 of 59 forecasts in a Bloomberg News survey of economists. Morgan Stanley & Co. and IHS Global Insight are the only institutions to predict a quarter-point reduction.

Press Conference

The decision is due at 1:45 p.m in Frankfurt and Draghi will hold a press conference 45 minutes later. The Bank of England will keep its bond-purchase target at 375 billion pounds ($441 billion) and maintain its key rate at 0.5 percent, separate surveys show. That decision is due at noon in London.

The euro rose 0.2 percent today to $1.3123 as of 9:58 a.m. in Frankfurt. The Stoxx Europe 600 index was 0.2 percent higher at 295.67.

Draghi may face questions on his determination to add more stimulus if the euro-area economy needs it. Policy makers have expressed doubts about the feasibility and effectiveness of measures he had held out in prospect.

‘Foreseeable Future’

Hours after Draghi mentioned the possibility of a negative deposit rate last month, Governing Council member Ewald Nowotny told CNBC that “it shouldn’t be seen as something that’s realistic in the foreseeable future.” Executive Board member Vitor Constancio said last week that policy makers are still analyzing the potential effects of such a move and are “far away from any decision.”

Economists including Clemens Fuest, president of the ZEW Center for European Economic Research in Mannheim, Germany, say the ECB should be careful about the message an unprecedented move into the sub-zero world of interest rates would convey.

“One mustn’t forget that something like that also reflects how the central bank assesses the economic situation,” Fuest said. “It’s not a step that should be taken now. The signal would be very negative.”

Data yesterday confirmed that the euro-area economy contracted 0.2 percent in the first quarter, after weakness spread to the region’s core. The German economy, Europe’s largest, expanded only 0.1 percent and France slipped into a recession.

‘Possible Stabilization’

Since the first quarter, indicators have improved. A gauge of euro-area manufacturing output rose more than initially estimated in May, economic sentiment as measured by the European Commission and Sentix investor confidence both rose after a slump in April, while consumer morale improved for a sixth month. Such reports suggest that the “few signs of a possible stabilization” Draghi cited earlier this week might turn into a recovery he has predicted since December.

The ECB will still revise down most of its growth and inflation forecasts today, said Marco Valli, chief euro-area economist at UniCredit Global Research. Officials predicted in March that the economy would contract 0.5 percent this year, before growing 1 percent in 2014. Inflation was seen averaging at 1.6 percent and 1.3 percent, respectively.

Draghi will also likely field queries on progress on a program to stimulate credit supply to smaller companies. Lending to the private sector hasn’t increased since January of last year, adding to market expectations that the ECB may purchase asset-packed securities to funnel money to the real economy.

‘Carried Away’

“The market gets carried away sometimes about what the ECB can do when they look at what gets done elsewhere,” said Nick Matthews, senior European economist at Nomura in London. “The ABS market is small and people looking for big bazookas might be disappointed.”

Since Draghi said last month that the ECB was working with institutions like the European Investment Bank to rekindle the ABS market, policy makers have backpeddled.

“Whatever could be done would not be extremely significant,” Constancio said last week. “It’s something that’s in the menu of things but I wouldn’t attribute a big importance. The public debate on that has been a bit overblown.”

Christian Schulz, senior economist at Berenberg Bank in London, said the ECB will “pin its hopes” on a summit of European leaders at the end of the month.

One year after governments agreed to establish a banking union to break the link between a country’s fiscal position and its banking sector, policy makers are pushing for progress on bank recapitalization and resolution in a bid to encourage governments to do their part to encourage lending and foster an economic recovery.

“The ECB cannot do much as a quick fix” and “only the cheapest option of all, dovish talk, seems likely at this meeting,” Schulz said. “But the ECB will keep as many options open as possible.”