Thursday 27 October 2016

Euro zone growth at four-year high, ECB leaves rates unchanged

Published 03/09/2015 | 13:19

President of the European Central Bank Mario Draghi. Ralph Orlowski
President of the European Central Bank Mario Draghi. Ralph Orlowski

Euro zone business activity accelerated at its fastest pace in more than four years last month, according to surveys that highlighted an ongoing divergence between laggard France and the other big economies in the currency bloc.

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A generally upbeat set of surveys will provide some welcome news for the European Central Bank, although they still only point to modest third-quarter GDP growth considering near-zero interest rates and the ECB's massive stimulus program.

The data, which come as official numbers showed retail sales rose less than expected in July, point to growth of about 0.4 percent in July-September, survey compiler Markit said. That rate is likely to be sustained in coming quarters, according to a Reuters poll on the long-term outlook a few weeks ago.

"The upwards momentum that the euro zone economy had has started to fizzle out, growth no longer seems to be accelerating," said Nick Kounis, head of macro and markets research at ABN AMRO. "There is a significant and rising risk that the ECB takes further action, maybe as early as today's meeting."

Although most economists expect no policy change at the ECB's meeting later on Thursday, many see a growing chance its trillion euro asset purchase program will be eventually be extended beyond a planned completion date of September 2016.

Markit's final August Composite Purchasing Managers' Index (PMI) beat an earlier estimate of 54.1, settling at 54.3 -- its highest level since May 2011. In July it registered 53.9 and has now been above 50, which denotes expansion, since July 2013.

Italian firms had their best performance since early 2011 and German growth strengthened. Spain's PMI also soared but it was a different story in France, the bloc's second biggest economy, where the composite PMI slumped to its lowest since the start of the year.

Retail sales rose 0.4 percent across the 19 nations using the euro in July, Eurostat said earlier, less than the 0.6 percent pick-up predicted in a Reuters poll.

Markets have see-sawed in recent days but were relatively calm on Thursday ahead of the ECB meeting and U.S. jobs data due on Friday which could be a major factor in determining whether the Federal Reserve raises interest rates later this month.

Meanwhile, the European Central Bank left interest rates unchanged on Thursday, holding them at record lows as it prints money to lift the economy and raise inflation.

The decision to leave the cost of borrowing unchanged was widely expected after the ECB cut rates to rock-bottom levels a year ago and repeatedly said they had hit "the lower bound".

At Thursday's meeting, the ECB left its main refinancing rate, which determines the cost of credit in the economy, at 0.05 percent.

It also kept the rate on bank overnight deposits at -0.20 percent, which means banks pay to park funds at the central bank, and held its marginal lending facility - or emergency overnight borrowing rate for banks - at 0.30 percent.

Draghi said the bank's 1 trillion euro-plus asset-buying program was working smoothly, if slowly, and the policy-making Governing Council was ready and willing to take further policy action but decided it would premature to do so now.

"In particular (the Council) recalls that the asset purchase program provides sufficient flexibility in terms of adjusting the size, composition and duration of the program," he told a news conference.

In one small change to the quantitative easing program, the bank agreed to increase the share of any sovereign bond issue it could buy to 33 percent from 25 percent, provided that did not give it a blocking minority among bondholders.

The ECB forecast that inflation would be a mere 0.1 percent this year, 1.1 percent in 2016 and 1.7 percent in 2017, compared with its June projections of 0.3, 1.5 and 1.8 percent respectively.

It lowered its forecast for growth in the 19-nation euro area to 1.4 percent in 2015, 1.7 percent next year and 1.8 percent in 2017, from June projections of 1.5, 1.9 and 2.0 percent respectively.

The forecasts, meanwhile, were compiled based on data taken before Aug. 12 and did not take into account the latest sharp economic deterioration in China, which posed "downside risks to the projections themselves", Draghi said.

However, he said the council tended to think the weaker inflation outlook was due to "transitory effects" but would closely monitor all relevant factors.

Draghi confirmed the ECB had cut Emergency Liquidity Assistance (ELA) to Greek banks for the second time in two weeks.

The ECB launched its 60 billion euro ($68 billion) per month quantitative easing program in March to boost consumer prices after a short bout of deflation. It is due to run until September 2016 but Draghi clearly hinted it could be extended.

The International Monetary Fund argued on Thursday that the ECB should consider extending QE, citing a rise in downside risks to the global economy due to a combination of threats, including China's slowdown and rising market volatility.

Oil prices are down 35 percent since May, iron ore is near an all-time low, the euro has unexpectedly firmed and Chinese growth, already a worry for the ECB in July, is slowing sharply. One of the bank's favored gauges of inflation expectations, the five-year, five-year euro zone breakeven forward, has fallen below 1.7 percent from 1.85 percent in July.


A majority of analysts polled by Reuters expect the ECB eventually to extend or increase its asset purchases. Three quarters said the bank has simply run out of tools and that adjusting QE, scheduled to run until next September, is its only viable option.

"Even if it appears too early to expect them to announce additional quantitative easing, central bank President Draghi should consider a more dovish rhetoric in order to prevent inflation expectations from falling further," Credit Agricole said in a note to clients.

Peter Praet, the bank's chief economist, has said markets should not doubt the ECB's "willingness and ability" to act. But comments from other rate setters like Benoit Coeure and Vice President Vitor Constancio suggest the bank will want to take time before taking action and prefers steady policy for now.

EU Financial Affairs Commissioner Pierre Moscovici played down the risks, predicting in an interview with Italian newspaper La Stampa that growth would become more robust.

"We have seen how monetary authorities, above all in China, have reacted well and have the tools to continue to do so," he said in the interview, published on Thursday.

"In such a context we can benefit from low energy prices, growth-friendly interest rates, while reform efforts by European governments are bearing fruit and create better conditions for growth."

Draghi highlighted some of the positive impacts of QE, even though inflation has stayed below 2 percent since early 2013.

Lending to euro zone firms in July grew at the fastest pace since early 2012, unemployment fell and the composite purchasing manager's index unexpectedly rose, offering a glimmer of hope that growth may be picking up after a lackluster second quarter.

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