Wednesday 29 March 2017

ECB's Draghi keeps interest rates at rock bottom in face of German backlash

Mario Draghi, President of the European Central Bank (ECB) Photo: AFP/Getty Images
Mario Draghi, President of the European Central Bank (ECB) Photo: AFP/Getty Images

ECB President Mario Draghi kept borrowing costs at rock bottom levels on Thursday, sticking to his course of ultra-loose monetary policy in spite of a barrage of German criticism of his recipe for tackling the euro zone's economic malaise.

Having yet to implement or fully explain some of the measures he announced last month, Draghi is set to give investors more information about the European Central Bank's latest plan to buy corporate bonds.

Read more: Germans round on ECB over policy, Draghi fighting back

The ECB announced that it would keep its main refinancing operations rate -- setting the price for banks to borrow -- at zero while it will continue to charge them 0.4 percent for parking money at the ECB.

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Having launched a 1.7 trillion euro ($1.92 billion) money-printing scheme and offered to pay banks to borrow from it to urge them to lend, the ECB will maintain a holding pattern for now.

Its biggest headache may be a nasty spat with Berlin after Finance Minister Wolfgang Schaeuble said its policies were causing "extraordinary" problems for Germany and were in part to blame for the rise of the right-wing anti-immigration Alternative for Germany (AfD).

Late on Wednesday, Schaeuble stuck to this tough line, saying that "a long period with zero and negative interest rates is not a sensible situation".

The ECB has been easing policy, charging banks ever more for hoarding their money with it and buying everything from state bonds to company debt to prop up a faltering economy.

Draghi may justify that by referring to flagging inflation, which the ECB uses as a guide to economic health and the success of its actions but which now stands at zero - far below the ECB's target of just below 2 percent.

Central banks worldwide have been keeping money cheap. Sweden's central bank expanded its asset-buying scheme on Thursday, despite the fact that its economy is in danger of overheating.

'ECB BASHING'

Disagreement with Germany, the strongest economy in the euro zone and de facto leader of the currency bloc, casts a cloud over the ECB.

"ECB-bashing has become fashionable in Germany," said Carsten Brzeski, an analyst of ING.

"This can paralyze the euro zone because it means the policy mix continues to be in deadlock. They will not move on issues such as Greek debt restructuring."

The ECB seems to have the edge in the debate for now after Schaeuble backtracked on some of his comments and Bundesbank chief Jens Weidmann, the ECB's biggest critic to date argued that its stance was appropriate.

The criticism is nonetheless damaging. "Any conflict between a major stakeholder and top management carries risks," Berenberg analyst Holger Schmieding said.

"‎It may destabilize the institution and blunt its message," Schmieding said. "The current dispute goes a bit beyond an awkward nuisance. At the margin, it may constrain the ECB's room for maneuver slightly."

Many in Germany blame low interest rates for sapping returns on their savings, while banks have protested loudly that it is squeezing their modest profits.

IMF figures suggest German and Portuguese banks will take the biggest earnings hit from falling interest rates.

Draghi, however, is likely to reject the German criticism, outlining an even darker path for growth and inflation if the ECB gives up.

The longer term prospects have barely improved. The euro zone five-year, five-year breakeven rate EUIL5YF5Y=R, a key market-based expectation that predicts long-term inflation, dipped to 1.39 percent on Wednesday, well below the 1.49 percent when the ECB announced its March package.

Of particular concern could be the nearly 5 percent rise in the trade-weighted euro since its early December low.

Reuters

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