Friday 15 November 2019

Thomas Atkins: ECB focus on interest rates and possible cut

ECB President Mario Draghi
ECB President Mario Draghi

FOR the first time in months, the European Central Bank's main focus at this week's policy meeting will be interest rates and whether they can be reduced to support a recession-bound euro zone economy.

A month after unveiling a potentially unlimited programme of bond-buying which only countries themselves can activate, the bank has little more it can do in the euro zone's debt crisis other than sit and wait for Spain to ask for help in taming the upward market pressure in its borrowing costs.

Officials have expressed enough concern about euro zone inflation, still above its target of just below 2pc, to convince financial markets they will hold off another cut in interest rates, already at a record low of 0.75pc.

But with years of outright recession beckoning for several of the bloc's economies, the case for further stimulus is strong and economists are already debating whether the bank can shift to the sort of negligible or "negative" rates run by Switzerland and Japan.

"The only question is whether they are going to cut rates or not," said ING economist Carsten Brzeski of this month's meeting.

"I think they won't ... This is the very last shot the ECB might have so it might be very hesitant to do it right now."

Only 14 of 73 economists polled by Reuters expect the central bank to lower rates on Thursday, when the Governing Council meets in Ljubljana in one of two annual meetings away from its Frankfurt base. A small majority do expect a cut by year-end to a record low of 0.50 percent.

While economic data has been pallid throughout the common currency area, inflation has remained stubbornly high. It accelerated to 2.7pc in September, the 22nd month in a row that it has been above the ECB's target of just below 2pc, limiting its room to manoeuvre.

Euro zone manufacturing put in its worst performance in the three months to September since the depths of the 2009 Great Recession, with factories hit by falling demand despite cutting prices, a business survey showed on Monday -- pointing to a new recession.

This has increased expectations of a rate cut by the end of the year, but the ECB does not want to use up its remaining arsenal to fight the crisis just yet.

ECB Executive Board member Benoit Coeure said last week that economic and inflation data did not justify an October cut - a view echoed by Austria's central bank governor Ewald Nowotny.

"Given that the ECB has already put so much on the table, they might well take a wait-and-see approach for now and if needed they can always cut rates at a later stage," said Christel Aranda-Hassel, economist at Credit Suisse.

The 17-country bloc's central bank has also become increasingly reluctant to cut its deposit rate, which provides a floor for money markets, to negative territory from the current zero, and ECB President Mario Draghi could repeat his message of those being uncharted waters.

Troubled debtor countries like Italy and Spain that need monetary stimulus the most are the ones who are receiving the least, because bank lending rates are well above those in stronger northern euro zone countries.

Thursday's meeting may produce some small efforts to stimulate lending in crisis-struck countries, such as widening the definition of accepted collateral for long-term funding to include private sector loans. But even on this, the ECB may decide to wait, having tweaked the rules just last month.

Also, while easing collateral rules might provide short-term gains for sovereign bonds, the ECB might prefer to wait for an application for aid before doing that.

"The ECB is unlikely to proceed with collateral easing until it is actually buying Spanish bonds, for concern that the increased liquidity may otherwise be used to - again - support the sovereign," Bank of America Merrill Lynch economist Laurence Boone said in a note to investors.

Markets are also eager to hear in the post rate-decision news conference any news on the Outright Monetary Transactions (OMT) bond programme, but could be left empty-handed.

"There's nothing that the ECB can do besides repeat what Draghi said last time," ING's Brzeski said. "Of course he has to be cautious not to appear softer, but I don't think he will."

Questions about the ECB's resolve have surfaced as Germany's Bundesbank maintains a drumbeat of criticism of bond buys, raising doubts whether the programme is really "unlimited", the word Draghi used to serve as a warning to markets betting against the central bank.

Spain, which has moved firmly to the centre of the crisis, last week unveiled a budget for 2013 based mostly on spending cuts in an effort to pre-empt the austerity that would necessarily accompany a bailout.

While markets have turned volatile again as street protests persist and concerns multiply about how soon Spain will act, the ECB itself has limited its room to move and Draghi is demanding strict conditionality before bond buys.


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