New Draghi Era Seen on Hold at ECB as Euro Area Recovers

Mario Draghi probably won’t embark on a new era for monetary policy just yet.

One year after the European Central Bank president said he could impose a negative deposit rate and a month after saying policy makers are willing to use measures such as quantitative easing, some officials have indicated they want more time to gauge the recovery. Banks from Scotiabank to Morgan Stanley say that while today’s interest-rate decision may be a close call, the 24-member Governing Council will opt not to act.

Keeping policy unchanged for now gives the ECB some leeway to ready itself for radical measures should its economic projections next month show the inflation outlook has worsened. With consumer prices rising at less than half the central bank’s goal, the 18-nation euro area remains susceptible to the threat of deflation.

“Our scenario remains for a prolonged status quo, but we agree that the risk of further ECB action remains significant,” said Frederic Pretet, a Paris-based strategist at Scotiabank. “Inflation remains uncomfortably low while the recovery is still fragile.”

The ECB will keep its benchmark rate unchanged at a record-low 0.25 percent in Brussels today, according to 56 of 58 economists in a Bloomberg News survey. The deposit rate, at zero since July 2012, will also remain on hold, according to 51 of 53 responses. The decision will be announced at 1:45 p.m. local time and Draghi will hold a press conference 45 minutes later. The bank holds two monetary-policy meetings a year outside its Frankfurt headquarters.

Inflation Target

Inflation in the euro area was 0.7 percent in April, according to an initial estimate from the European Union’s statistics office. While that’s up from 0.5 percent in March, it was below economists’ forecasts and compares with the ECB’s goal of just under 2 percent. The rate has been below 1 percent since October.

At the same time, economic data have signaled that the currency bloc is recovering from its longest-ever recession, which ended last year, and survey indicators point to a further pickup in activity.

Service industries in Spain and Ireland, which have both exited international bailout programs in the past six months, showed the fastest growth since before the financial crisis in March, according to purchasing managers indexes by Markit Economics this week. Consumer confidence in the euro area unexpectedly increased in April, a European Commission report showed last month.

Norway, Indonesia

“Although inflation remains well below target and looks set to remain weak, the economic recovery gradually continues to gain momentum,” said Ben May, an economist at Oxford Economics Ltd. in London. “This suggests that the ECB will refrain from providing further policy stimulus in May.”

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 ($636 billion), according to separate Bloomberg surveys.

Norway’s central bank kept its main interest rate at 1.5 percent today to support an expansion as oil and gas investment slows. In Indonesia, where economic growth has slowed to the weakest in more than four years, the central bank held its reference rate at 7.5 percent as policy makers seek to narrow a gap in the current account.

Draghi Contingencies

The ECB will publish revised economic projections after its June 5 policy meeting. It predicted in March that gross domestic product in the euro area will expand 1.2 percent this year, accelerating to 1.8 percent in 2016, and that the inflation rate will average 1 percent this year, rising to 1.5 percent in 2016.

ECB Governing Council member Ewald Nowotny said last month that the growth forecasts may be raised, and that the central bank should wait until at least June before acting. Council member Ardo Hansson said policy makers should see how the data evolve over the next few months. Jens Weidmann, Germany’s representative at the ECB, said officials must focus on the path of inflation rather than past figures.

Speaking in Amsterdam on April 24, Draghi provided his most-detailed explanation yet on which contingencies could trigger more stimulus.

A worsening of the medium-term inflation outlook would require the ECB to “meaningfully” ease policy and would justify a broad-based asset-purchase program, he said. That’s unlikely to be an early choice, according to Elga Bartsch, chief European economist at Morgan Stanley in London.

Small Steps

“Instead of launching into full-blown QE, we expect the ECB to adopt a number of smaller policy steps in the coming months to further support the recovery, address the much-debated lowflation problem, and to contain the strength of the currency,” Bartsch said. “We expect another small reduction in the refinancing rate in June, followed or possibly even accompanied by a deposit-rate cut.”

Rate cuts or liquidity injections could be a response to “unwarranted” monetary tightening caused by higher money-market rates, higher bond yields or a stronger euro, Draghi said in Amsterdam.

That might mean halting the drain of liquidity added by bond-purchases under the expired Securities Markets Program. Pausing the weekly operation, which has failed for the past four weeks, would add about 168 billion euros into the financial system, though Draghi said in February that the effects would be “relatively limited” as the bonds mature.

Euro Trigger

The euro has climbed about 9 percent against the dollar since July, curbing the price of imported goods and undermining the competitiveness of euro-area companies. It advanced as high as $1.3951 this week, taking it close to the $1.40 level that some investors have identified as a trigger that may spur a further rally. Draghi has said a rising exchange rate has contributed to low inflation and gains may necessitate stimulus. The currency was up 0.2 percent at $1.3931 at 10:18 a.m. Frankfurt time today.

In the money markets, the average cost of overnight, unsecured lending between banks in the euro area, known as Eonia, rose to 0.254 percent last month. That’s three times as high as a year earlier and above the ECB’s benchmark rate for the first time since October 2008, signaling investors may be returning to pre-crisis behavior before the recovery is entrenched.

Eonia Settings

“While Eonia settings have risen and become somewhat more volatile of late, we believe the ECB views this as associated with a reactivation and reintegration of the euro-area interbank market,” Huw Pill, chief European economist at Goldman Sachs Group Inc. in London, said yesterday, adding that there’s a chance the central bank will act in the coming months.

“Should the ECB view the upward drift in Eonia settings seen since the start of the year as undesirable -- given concerns about deflation risks -- it may choose to shift its key interest rates down,” Pill said in a note to clients. “The probability rises to around 40 percent in June or July, even as no change remains our base case.”

(An earlier version of this story corrected the month of previous inflation data to March.)

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