Draghi Says ECB to Act If Needed to Control Money Markets

European Central Bank President Mario Draghi said he’s ready to take any necessary measures to keep money-market rates in check as he tries to steer Europe’s banks through the early stages of an economic recovery.

“We’ll remain particularly attentive to developments which may have implications to monetary policy and consider all available instruments,” Draghi said at a press conference in Paris today, reiterating comments he made last month. “We have a vast array of instruments to this extent and we exclude no option in order to address the needs as is most appropriate.”

Draghi spoke after the ECB’s Governing Council left its main refinancing rate at a record low of 0.5 percent for a fifth month. The decision was predicted by all 52 economists in a Bloomberg News survey. Officials held the deposit rate at zero and the marginal lending rate at 1 percent.

The ECB holds its meetings outside of its home city of Frankfurt twice a year. The October meeting is a day earlier than normal because of a public holiday in Germany tomorrow.

The central bank is trying to contain volatility in market rates as investors face risks ranging from a squeeze on excess liquidity to stress tests on banks’ balance sheets. While Draghi didn’t announce any new liquidity measures today, he repeated that the ECB is prepared to announce another long-term refinancing operation for Europe’s financial system if needed.

Market Reaction

The overnight rate that banks expect to charge each other by the ECB’s September 2014 rate meeting, as measured by Eonia forward contracts, rose as high as 0.23 percent after Draghi’s comments, from 0.21 percent before the press conference. While that still down from 0.3 percent on Sept. 5, the date of the ECB’s last rate decision, it compares with less than 0.1 percent in May.

The euro climbed, rising as high as $1.3607 from $1.3523 at the start of the press conference. The yield on Germany’s two-year government bond fell 1 basis point to 0.16 percent.

In addition to Draghi refraining from signaling any new policy measures, the single currency advanced after Italian Prime Minister Enrico Letta won a confidence vote in parliament, avoiding the need for another election.

The ECB pumped more than 1 trillion euros ($1.4 trillion) of three-year loans into the financial system during the region’s debt crisis and gave banks the option to repay the emergency cash early. As banks do that amid a recovering economy, excess liquidity in money markets is declining, threatening to push borrowing costs higher.

Rate Discussion

The ECB president said today that policy makers considered a cut in their main interest rates and decided against it. He has pledged since July to keep the rates at or below the current level for an extended period of time.

The health of the euro region’s economy has shown signs of improving since last month’s ECB meeting. Economic confidence as measured by the European Commission rose for a fifth month and a gauge of factory output showed a third month of expansion.

Draghi said that lending to households and companies, which fell by a record in August, may start to rise before the ECB completes a review of bank balance sheets next year.

“Credit flows are still weak, I would even say very weak, even though we see a significant improvement in fragmentation on the funding side,” he said. “We have frankly strong hopes that credit will recover before the end of the asset quality review.”

Review Risk

Risks to the recovery include a review of bank balance sheets to be led by the ECB starting next year before it takes over as supervisor for euro-area lenders. Stress tests that form part of the assessment remain a potential source of bank turmoil as no plan to cover capital shortfalls discovered during that process has yet been agreed by European Union leaders.

“On the backstops, that’s another thing that quite astonishes me as the doubts that have been expressed about whether national backstops will be in place by the time we start our Single Supervisory Mechanism,” Draghi said. “In fact, there is an explicit reassurance about this in the conclusion of the last European Council, where there is an explicit reference to national backstops.”

Draghi warned that market interest rates are a signal as to whether governments are pursuing necessary economic reforms.

“The message markets are sending -- not only markets, all of you -- to countries we mentioned is very simple: stability and reforms,” he said. “The greatest pressure should come from the inside. The reforms should be made for their own sake; they shouldn’t be pressed by markets.”

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