ECB Holds Rates as Crisis Damps Growth Outlook
The European Central Bank left interest rates unchanged and may lower its inflation and growth forecasts as the region’s debt crisis worsens.
ECB officials meeting in Frankfurt today kept the benchmark rate at 1.5 percent, as predicted by all 57 economists in a Bloomberg News survey. President Jean-Claude Trichet, who holds a press conference at 2:30 p.m., may say inflation risks are no longer on the upside, signaling rates are now on hold after two increases this year, economists said.
The spreading debt crisis is sapping confidence in European banks and driving up market borrowing costs, prompting economists such as Nouriel Roubini and Nobel Prize winner Joseph Stiglitz to urge the ECB to quickly cut rates. Economists who closely watch the ECB say it is more likely to use other tools first, such as reintroducing 12-month loans to banks.
“It would take a full-blown recession for the ECB to really reverse course,” said Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co. in London. “Having just raised interest rates it would be very, very embarrassing to say sorry, we apparently made a mistake. It is much more likely that they will offer even more liquidity assistance to banks to help ease tension in the inter-bank markets.”
The Bank of England today kept its key rate at a record low of 0.5 percent and maintained its bond-purchase program at 200 billion pounds ($320 billion).
Focus on Growth
Central banks around the world are refocusing on supporting growth. Yesterday the Bank of Canada said there is a “diminished” need for it to raise interest rates, Sweden’s Riksbank abandoned a planned increase and the Reserve Bank of Australia signaled it is prepared to keep rates on hold.
Fears of a renewed global recession have caused stocks to tumble around the world and forced Japan and Switzerland to intervene to stop their currencies appreciating as investors seek havens.
Manufacturing slumped in Europe and Asia last month, while weak growth and stubbornly high unemployment in the U.S. have fueled calls for the Federal Reserve to embark on a third round of quantitative easing. U.S. President Barack Obama will today propose a more than $300 billion stimulus plan to lawmakers in Washington.
The ECB will cut its forecasts for growth and inflation when it issues new economic projections today, said Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc in London. It may lower its 2012 growth estimate to 1.4 percent from 1.7 percent and its inflation forecast to 1.6 percent from 1.7 percent, he said.
Trichet said on Aug. 29 that the bank was reviewing its assessment of inflation risks, which in last month’s policy statement it described as being “on the upside.”
“The language will probably shift to neutral on inflation and downside risks to growth, which is enough to flag that the ECB is on hold,” said Laurent Bilke, a former ECB economist now working for Nomura International in London. “That is the intermediate step before they would even consider any easing. It is very unlikely that the ECB would do a massive U-turn so soon. That is just not how it operates.”
While euro-area growth slowed more than economists forecast in the second quarter, to 0.2 percent from 0.8 percent in the first, inflation at 2.5 percent remains in breach of the ECB’s 2 percent limit.
The central bank raised rates in April and July to combat price pressures. Since then, the debt crisis that had already engulfed Greece, Portugal and Ireland has spread to Italy and Spain, the region’s third and fourth-largest economies, forcing the ECB to start buying Italian and Spanish bonds on Aug. 8.
Investors have increased bets that the ECB will cut its key rate by the end of the year, Eonia forward contracts show.
“The ECB made its biggest mistake in its history hiking rates this year,” Roubini, co-founder and chairman of Roubini Global Economics LLC, said in an interview on Sept. 6. “They’ve created more sovereign debt problems. They’ve created more banking problems.”
The Euribor OIS spread, a measure of banks’ reluctance to lend to each other, rose to 79 basis points yesterday, the highest in almost 2 1/2 years.
Juergen Michels, chief euro-region economist at Citigroup Inc. in London, said the economic outlook is not gloomy enough to prompt rate cuts and the ECB is more likely to introduce new measures to keep banks awash with cash, perhaps as soon as today. That could include an additional six-month loan or reintroducing a 12-month operation, he said.
Policy makers could also look at cutting the deposit rate to push down market borrowing costs and increase the penalty banks incur when they park cash with the ECB rather than lend it to other institutions, Michels said.
The ECB has reversed direction on rates before. It raised its benchmark in July 2008 before embarking on the most aggressive easing in its history in October after the collapse of Lehman Brothers Holdings Inc. triggered a global recession. Deutsche Bank Chief Executive Officer Josef Ackermann said on Sept. 5 that current market conditions remind him of that time.
“The experience of late 2008 indicates that the ECB can change course very quickly,” said Cailloux, who sees a 40 percent chance that the ECB will cut rates by year-end. “Given how quickly the situation has deteriorated over the past month, we do not believe the ECB will be in a position to provide much credible forward-looking guidance.”
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