Saturday 19 August 2017

ECB keeps key interest rates unchanged as 'increasingly solid' recovery recognised

ECB president Mario Draghi
ECB president Mario Draghi

David McHugh and Pan Pylas

The European Central Bank (ECB) has kept its stimulus programme and interest rates unchanged, even though it conceded that the economic recovery in the 19-country eurozone is strengthening.

Though a raft of economic indicators in recent weeks have pointed to a strengthening recovery, there was little expectation the bank would adjust its policy in the run-up to the second round of France's presidential election.

Anti-euro candidate Marine Le Pen is battling pro-EU front-runner Emmanuel Macron for the French presidency. A victory for Ms Le Pen on May 7 could unsettle financial markets since she has advocated taking France out of the euro.

ECB president Mario Draghi suggested that the election had no bearing on the bank's decision and that the subdued inflation outlook remains the principal driver of policy.

He said at a press conference: "We actually don't do monetary policy based on likely election outcomes.

"We have not seen sufficient evidence to alter our inflation outlook."

Mr Draghi did offer a concession to the improving economic outlook, listing better data. However, he reiterated the bank's view that the risks remain tilted to the downside.

He said: "Incoming data since our meeting in early March confirms that cyclical recovery of euro area economy is becoming increasingly solid and that downside risks have further diminished."

In the statement accompanying the decision, the ECB omitted any hint of when the bank might taper off its extraordinary support measures.

Speculation of such a taper has grown as surveys show the eurozone economy accelerating sharply this year.

That was further evidenced in a survey earlier from the European Union's executive Commission, which found that economic sentiment in the eurozone is at a near 10-year high.

"It's true that growth is improving; things are going better," Mr Draghi said, describing the recovery as "solid and broad" as against "uneven and fragile" a few years back in 2013.

However, the ECB does not seem to want to take any chances. At 1.5pc, inflation remains below the ECB's goal of just under 2pc, and unemployment, though on a downward trend, remains elevated at 9.5pc.

Its statement repeated past wording that indicates it even "stands ready to increase" stimulus if the outlook for growth and inflation worsens.

Analysts consider this wording a way of discouraging investors from speculating about the end of the stimulus - which might prematurely drive up market interest rates, blunting its intended benefits.

The €60bn (£51bn) per month in bond purchases push newly printed money into the economy in an effort to boost inflation, which is considered too weak at 1.5pc annually.

The ECB has trimmed the purchases, which started in March 2015, from €80bn a month as of April. But it insists they will continue at least until the end of the year, and in any case until inflation shows signs of turning convincingly upward towards the bank's goal of just under 2%.

Mr Draghi has said they will not be suddenly shut off after that, but instead gradually reduced, although he has not indicated when this tapering will begin.

Printing money and adding it to the economy can raise inflation, lower interest rates and make it easier for businesses to get the credit they need. It is considered an extraordinary step undertaken to keep Europe from falling into a chronic spiral of falling prices after the shock of the debt crisis that started in 2009 with financial trouble in Greece.

The eventual withdrawal of the stimulus will have a wide-ranging impact on businesses, governments, investors and consumers.

Mortgage payments will tend to rise because of higher interest. Higher rates would make it easier in some cases to save for retirements or fund a pension plan, and would make bonds and bank time deposits more attractive compared to stocks.

The ECB is lagging far behind the US Federal Reserve, which is already raising interest rates after the US economy recovered faster from the Great Recession. ECB officials have said they will not start raising benchmark rates until after the bond purchases end.

Several analysts think the central bank will change the wording of its statement in its June or July meetings to signal that the economy is less in need of help. That could lead to an announcement in September on the timing of the taper to the stimulus.

Key wording currently includes the bank's statement that economic risks are "tilted to the downside," meaning it is more likely the economy and inflation will grow less than expected rather than more than expected. Another key statement is the promise to increase the stimulus if things worsen.

Other stimulus measures include keeping the bank's interest rate benchmark at a record low of zero.

That rate largely steers short-term rates and keeping it that low makes it cheaper for banks to borrow money on the interbank market, which in turn would mean in lower borrowing costs for businesses.

The ECB has also imposed a minus 0.4pc interest rate on deposits it takes from commercial banks. That is, in essence, a tax aimed at pushing banks to lend the money rather than leave it at the ECB's super-safe overnight deposit facility.

Press Association

Also in Business