Draghi Chasing Europe Growth Seen Justifying ECB Rate PauseJeff Black and Jana Randow
Mario Draghi may have all the information he needs to do nothing on interest rates.
A month after saying he needs more data to make a decision, stronger-than-expected output and inflation and rising economic confidence might spare the European Central Bank president for now from radical steps such as negative rates. With 40 out of 54 economists in a Bloomberg News survey predicting no change in the benchmark rate, attention has turned to whether Draghi will instead roll out plans to boost liquidity or stimulate lending.
Draghi has limited room left to steer the 18-nation currency bloc away from deflation, as the ECB’s key rate is just a quarter percentage point above zero. While other measures are on the table, including the release of cash linked to crisis-era bond purchases, his main scenario is to let the gradual recovery erode idle productive capacity and boost prices.
“For now, the deflationary threat is insufficient” for the ECB to use its strongest measures, said Elwin de Groot, senior market economist at Rabobank in Utrecht, Netherlands. “We could well see a repeat of February, with ECB President Draghi adding more items to his checklist, and removing a few others, in order to buy extra time. However, it will be a very close call.”
The ECB will announce its interest-rate decision at 1:45 p.m. in Frankfurt and Draghi will hold a press conference 45 minutes later. The Bank of England will probably keep its benchmark rate at a record-low 0.5 percent at 12 p.m. in London, while its bond-purchase plan will stay at 375 billion pounds ($627 billion), according to separate Bloomberg surveys.
When Draghi said last month that policy makers “need to acquire more information” to analyze the “complexity of the situation” in the euro-area economy, his watch list included four bullet points: growth data from the end of last year, the impact of turbulence in emerging markets, credit supply to companies and households, and new economic forecasts prepared by the ECB’s staff.
While the recovery remains fragile, data in the past four weeks have been encouraging. Gross domestic product in the bloc grew 0.3 percent in the fourth quarter, more than economists predicted, bolstered by stronger expansions in Germany, France and the Netherlands and a return to growth in Italy. Economic sentiment rose to the highest level in more than 2 1/2 years in February, and services and manufacturing expanded the most since June 2011.
The euro has gained almost 1 percent in the past month and was at $1.3729 at 8:21 a.m. Frankfurt time, little changed on the day. Overnight borrowing costs in the euro area, a signal of tension in financial markets, have stabilized since rising above the ECB’s benchmark rate for four consecutive days in January.
In a sign that confidence is returning to developing nations, the MSCI Emerging Markets stock index rebounded 3.2 percent in February after slumping 6.6 percent the prior month.
Draghi told European Parliament lawmakers in Brussels on March 3 that officials are seeing progress in lending as a slump in credit eases and surveys signal an improvement in loan demand.
The ECB’s updated projections for euro-area growth and inflation will be released today, including forecasts for 2016 that extend the central bank’s outlook to three years for the first time.
“Activity numbers are actually picking up quite decently and the ECB is likely to revise up its GDP forecast at least for this year,” said Anders Svendsen, an economist at Nordea Bank Denmark A/S in Copenhagen. “Yes, inflation is low and will remain low for a long time, but this is not new to the ECB, and inflation is probably very close to bottoming out.”
The ECB predicted in December that the 18-nation economy would expand 1.1 percent this year and 1.5 percent in 2015. It said inflation will average 1.1 percent and 1.3 percent, respectively, below the 2 percent level the ECB defines as price stability.
Inflation has picked up since reaching a four-year low of 0.7 percent in October. Annual consumer-price gains held at 0.8 percent in the first two months of this year, exceeding economists’ forecasts. Stripped of volatile components such as energy and food, core inflation was 1 percent last month, the highest level since September.
ECB officials will debate how likely that improvement is to be sustained. Governing Council member Ewald Nowotny has said that inflation may “self-correct” as the economy improves, while Executive Board member Benoit Coeure has expressed more concern. The euro region is “closer to the area where inflation expectations could be altered and create downside risks to price stability,” he said in an interview with Slovenian newspaper Delo published on the ECB website on Feb. 15.
Inflation expectations as measured by 5-year/5-year forward breakeven rates in Germany, the region’s largest economy, dropped to the lowest in 11 months in February. Morgan Stanley, which predicts the ECB’s benchmark rate will be cut to 0.1 percent today, estimates there is a 35 percent risk the euro area slides into deflation. Societe Generale SA, which forecasts no change in rates, puts the probability at 15 percent.
Those perceived risks may mean policy makers feel they need to act, even as the data support the case for keeping policy unchanged.
“Most ECB Governing Council members have tried to keep all options open for the March meeting,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt and the only forecaster to predict a cut in the deposit rate, currently at zero.
Halting the absorption of liquidity created by bond purchases under the ECB’s now-defunct Securities Markets Program may be a “compromise” solution, even though it will “help little in addressing alleged disinflation risks,” he said.
Pausing the weekly operations would add about 175 billion euros ($240 billion) of liquidity to the financial system. It would also pose a challenge to the ECB’s credibility. Former ECB President Jean-Claude Trichet made sterilization part of the SMP program in 2010 to allay concerns that the bond-buying would stoke inflation.
“Credibility is critical, but never more so than in an environment when the central bank is using forward guidance on interest rates and liquidity provision to stabilize the situation,” said Richard Barwell, senior European economist at Royal Bank of Scotland Plc in London. “It is unwise for the council to go back on commitments it made in the past without an exceptionally good reason.”
Trichet said this week that pausing the operation is “certainly possible.” Germany’s Bundesbank, whose presidents have opposed government-bond purchases and repeatedly warned of the risks they entail, said on Feb. 17 that it would support such a move.
Other ways to ease funding conditions include lowering reserve requirements, offering more long-term loans or bolstering the market for asset-backed securities, either by purchasing the securities outright or encouraging their use as collateral in refinancing operations.
“Clearly, a small refi-rate cut and/or liquidity injections would not be a game-changer for growth and inflation,” said Reinhard Cluse, chief European economist at UBS AG in London. “But from the ECB’s point of view, the key advantage would be to buy itself more time to assess how strong the forces of disinflation will continue, and to decide whether stronger and unorthodox -– and hence more controversial –- instruments will be needed” in the second half of the year.