Wednesday 16 October 2019

ECB stuck on zero as rate move delayed again

Policy: Mario Draghi
Policy: Mario Draghi
ECB Vice President Luis de Guindos
Vitas Vasiliauskas, governor of Lithuania’s central bank

David Chance

Faced with weakness in the eurozone economy and rising trade tensions, the European Central Bank pushed back the date for its first move to hike interest rates from zero until at least the middle of next year.

At its policy meeting yesterday in the Lithuanian capital of Vilnius, the ECB said it would continue to pay commercial banks to loan out money, in a bid to boost lending and growth in the ailing single currency area. It cut growth forecasts for the eurozone to 1.4pc for 2020 and 2021.

Please log in or register with for free access to this article.

Log In

Inflation is seen at 1.3pc this year, 1.4pc next year and 1.6pc in 2021, still well shy of the central bank's 2pc target.

The task for getting this right now falls to former Central Bank of Ireland Governor Philip Lane, who made his first outing as ECB chief economist yesterday.

The ECB has been predicting stronger inflation since 2013 and has missed every time, undermining its credibility, according to many economists.

Andrew Kenningham, chief Europe economist at Capital Economics, noted that financial markets had been pricing in a rate cut over coming months and called the ECB's latest moves "a bit disappointing". The initial response in markets was to push the euro to two-month highs against the dollar.

It once again was left to ECB President Mario Draghi to save the day. In his press conference after the rate decision, he said the bank's rate-setters had discussed what policies could be used in the event that the economic outlook worsened more than expected.

The problem is that Mr Draghi's term ends on October 31. Uncertainty reigns over who will succeed the man credited with saving the eurozone.

One frontrunner is Bundesbank President Jens Weidmann, who has been critical of the ECB's low rates and a bond purchase programme that has hoovered up €2.3trn of eurozone government securities.

Carsten Brzeski, chief economist at ING Germany, said the ECB's change in forward guidance "will actually bind Draghi's successor to continue with his legacy for almost a year, at least".

Even as the ECB prevaricated, it appeared that the US Federal Reserve was readying for action that could see it cut interest rates.

The Fed has been far ahead of the ECB on policy since the start of the financial crisis, taking more aggressive action earlier that kickstarted a US economic expansion that is now close to 10 years old, while the ECB raised rates twice during the financial crisis and was forced to backtrack.

The Fed looks as if it will be more agile once again.

Earlier this week, Fed chairman Jerome Powell said he was ready to act to sustain economic growth if it was threatened by growing tensions over trade that have been stoked by US President Donald Trump's hiking of tariffs on China and threat to impose them on Mexico.

The Fed Funds rate stands at 2.25-2.5pc, which means the US central bank has more room to cut interest rates to revive the economy than the ECB, which is at zero.

Even with that extra capacity for rate reductions, less room exists than in previous recessions when the Fed cut rates from much higher levels.

Steve Blitz, chief US economist at TS Lombard, warns that Mr Powell will have to move quickly to cut rates.

"The tariff clash obviously complicates their thinking about what to do next, given that a monetary response alone is ill-suited to fight a trade war. Nevertheless, an insurance cut was promised, and September increasingly looks like it will be a cut too late if the trade war rolls on, as it now looks set to do," Mr Blitz said.

Eurozone governments are bound by the terms of the Stability and Growth Pact. This means the fiscal firepower they have to offset any economic downturn is limited and that leaves the ECB as the only game in town. While a sudden reversal of Mr Draghi's policies looks unlikely, the institution may remain caught in the headlights until a new ECB president is installed.

"Despite the overall pessimism and numerous references to 'prolonged uncertainty' and the potential economic damage of protectionism, Mario Draghi refused to give any indication that the ECB have moved closer to cutting rates further or reopening their asset purchase programme," said Ronan Costello, head of Euro money markets at Bank of Ireland.

Irish Independent

Also in Business