ECB Keeps Rates on Hold as Confidence Returns to Region

The European Central Bank kept interest rates unchanged at a record low as improving confidence underscored President Mario Draghi’s timetable for an economic recovery later this year.

Policy makers meeting in Frankfurt today left the main refinancing rate at 0.5 percent after reducing it by a quarter point last month, as predicted by 57 of 59 forecasts in a Bloomberg News survey of economists. Morgan Stanley & Co. and IHS Global Insight were the only institutions to predict a cut. Draghi will hold a press conference at 2:30 p.m.

A month after Draghi left investors to ponder a menu of further measures that the ECB might consider to aid economic growth, he may point to improving sentiment as justification for keeping borrowing costs unchanged. Still, economists say officials probably need to cut their outlook for growth after data showed the euro region’s recession extended through the first quarter and Germany’s economy barely grew.

“Draghi’s rhetoric is poised to remain dovish, confirming that the ECB stands ready to act further if needed,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. Still, “we do not expect any bold announcement on unconventional policy,” he said.

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 ($580 billion) and maintained its key rate at 0.5 percent.

Adding Stimulus

At the press conference, Draghi may face questions on his determination to add more stimulus if the euro-area economy needs it. 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.”

Economy Contracts

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.

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, UniCredit’s Valli said. 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.

ABS Purchases

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 last year, adding to market expectations that the ECB may purchase asset-packed securities to funnel money to the real economy.

“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.

Not ‘Significant’

“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.”

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