Draghi Seen Pausing in Signal of Nascent Euro-Area RecoveryJeff Black and Jana Randow
For investors waiting for Europe’s long-delayed recovery to appear, no news from Mario Draghi today may be a good sign.
As evidence mounts that the euro region’s economy is pulling out of its longest-ever recession, economists from HSBC Holdings Plc to Standard Chartered Plc say the European Central Bank president may feel confident enough to refrain from any new policy tools or elaborate on last month’s unprecedented pledge to keep interest rates low for an extended period.
“People are a bit more optimistic about the second half,” said Janet Henry, chief European economist at HSBC in London. The ECB is “keeping the door open to doing more, if and when required, but at the moment the baseline scenario is intact that we do get some kind of recovery later in the year.”
The task for Draghi will be to foster growth while assuring financial markets that the ECB won’t tighten monetary policy too soon, as it did in 2011. While euro-area manufacturing grew at a faster pace than estimated in July for the first expansion in two years, and business confidence improved for a third month, lending to companies and households across the 17-member bloc fell the most on record in June.
Out of 63 economists in a Bloomberg News survey, 62 expect the ECB to keep the benchmark interest rate unchanged at a record low of 0.5 percent when policy makers meet in Frankfurt today. Wells Fargo Securities forecasts a quarter-point cut. The ECB will publish its decision at 1:45 p.m. and Draghi will hold a press conference 45 minutes later.
The Federal Reserve said yesterday after a meeting of policy makers that persistently low inflation could hamper the economic expansion and pledged to keep buying $85 billion in bonds every month.
The Bank of England’s nine-member Monetary Policy Committee will hold its target for quantitative easing at 375 billion pounds ($570 billion) and the benchmark interest rate at 0.5 percent when it meets today, according to the median estimate in two Bloomberg News surveys.
The European Commission’s gauge of economic confidence in the euro area climbed to the highest level in 15 months in July. An index of manufacturing increased to 50.3, higher than the estimate of 50.1 published by London-based Markit economics on July 24. A reading above 50 indicates growth.
Countries in both the core and the periphery of the currency bloc have shown signs of improvement. Germany, Europe’s largest economy, saw business confidence increase for a third month and unemployment hold near a two-decade low in July. Spain’s economic contraction slowed to 0.1 percent in the second quarter from 0.5 percent in the three months through March.
“The recent data in the euro area has been rather good,” said Christoph Kind, head of asset allocation at Frankfurt Trust in Frankfurt. “You could in principle say that the recession is over. The ECB could argue that the data are proof that the expansive monetary policy is bearing fruit, but it’s by no means the time to change their guidance.”
One sign that the euro-area recovery has a long way to go is unemployment, which held at a record 12.1 percent in June, according to data from the European Union’s statistics office in Luxembourg yesterday. Spain had the highest rate at 26.3 percent, while the region’s youth unemployment rose to 23.9 percent.
Further risks include demand from outside Europe. The International Monetary Fund on July 9 cut its forecast for global economic growth in 2013 to 3.1 percent from 3.3 percent, citing an extended slowdown in emerging markets and a weaker expansion in the U.S. Growth has slowed for the past two quarters in China, the world’s second-biggest economy.
The euro area’s recession is also still dragging on credit. Bank lending to private-sector companies and households shrank 1.6 percent in June from a year earlier, the most since the euro was founded in 1999, as companies in countries such as Spain and Greece struggled to get affordable funding. Draghi last month cited “weaker and weaker” credit flows as one reason for keeping interest rates low.
“Credit tends to follow the economic cycle, not lead it,” said Christian Schulz, senior economist at Berenberg Bank in London. “In the initial stages of the recovery, households and companies use their cash reserves to fund spending and investment before lending takes off again.”
With economic growth still not guaranteed, investors are looking for more explicit forward guidance beyond Draghi’s pledge on July 4 to keep rates low “for an extended period.” The U.S. Federal Reserve first used that communication tool in August 2003 when it said monetary policy would be accommodative “for a considerable period.” That turned out to be 10 months, with the Fed raising rates in June 2004.
While the Fed reintroduced guidance in 2008, it was only in August 2011, as the European debt crisis threatened to hold back the U.S. recovery, that it specified “at least through mid-2013.” In December 2012 it set economic criteria for moving away from low rates.
It may be too early for Draghi to consider expanding his guidance to include dates or economic targets, according to Nick Kounis, head of macro research at ABN Amro NV in Amsterdam.
“Right now it’s being used to make sure that there isn’t an exit priced in in the foreseeable future,” he said. “Draghi wants to keep short-term rates anchored, even as the economy improves. I’m becoming more confident that the euro area is set for some growth in the next few months, but the health warning is that it is all going to be excruciatingly slow.”
The ECB’s six-man Executive Board is also increasingly open to publishing the minutes of Governing Council meetings. Benoit Coeure and Joerg Asmussen voiced support for publication on July 29. Draghi backed the idea in comments in Germany’s Sueddeutsche Zeitung yesterday. Jens Weidmann said he would welcome a timely release of transcripts to make the ECB’s decisions more comprehensible, Handelsblatt reported today.
Jean-Claude Trichet, the former ECB president, said in Die Zeit today that publishing the minutes isn’t ideal.
Publishing the minutes could be “one element of a broader set of reforms which would be designed to educate the market about the policy debate within the council and reduce the hyperactive response to every utterance,” said Richard Barwell, senior European economist at Royal Bank of Scotland Plc in London. “Minutes could therefore complement the guidance in pursuit of stable money market rates.”
Money-market rates reflect how well the ECB’s policy stance filters into the financial system and the real economy, as well as providing an indication of investors’ expectations for the future path of interest rates.
The ECB said on July 11 that a “sustained upward trend” in the rates that banks charge each other led to a restriction in money-market credit conditions in late June that offset the loosening of standards induced by its May rate cut.
The market expects overnight borrowing costs to stand at 0.22 percent by the ECB’s July 2014 policy meeting, according to the forward rate on Effective Overnight Index Average swaps. That’s up from 0.15 percent the day after Draghi’s interest-rate pledge. The measure rose as high as 0.42 percent on June 24.
The relatively restrained increase in money-market rates may be sufficient reason for Draghi to keep his guidance unaltered while watching for the economic recovery to take hold, according to Sarah Hewin, head of Europe research at Standard Chartered in London.
“I do see the economy improving and growth was probably positive in the second quarter,” she said. “It was quite a big step last month to talk about rates remaining at the present or lower level. Having seen a stabilization since then, Draghi can afford to just reiterate his statement.”