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Tags: ECB | Rates | Italy | Turmoil

ECB Keeps Rates Unchanged as Italy Turmoil Threatens Recovery

Thursday, 07 March 2013 07:56 AM

The European Central Bank left interest rates on hold as it gauges how big a threat Italy poses to the economic recovery.

Policy makers meeting in Frankfurt Thursday kept the benchmark rate at a record low of 0.75 percent, as forecast by 56 of 61 economists in a Bloomberg News survey. President Mario Draghi holds a press conference at 2:30 p.m. to explain the decision.

Budget cuts and economic reforms were rejected by more than half of voters in an Italian election last month, undermining optimism that the euro area will shake off the sovereign debt crisis and gradually climb out of recession this year. With economists predicting the ECB will lower its growth and inflation forecasts today, investors are looking for signs from Draghi that the ECB will do more to foster a recovery.

“It’s up to governments to implement structural reforms and Draghi will make clear what the ECB can do compared to what governments can do,” said Marco Valli, chief Eurozone economist at UniCredit Global Research in Milan. “But if the Italian situation impacts monetary policy or poses a downside risk to inflation, they’ll have to act.”

Policy options available to the ECB include rate cuts, more long-term loans to banks, and measures to encourage bank lending to small and medium-sized companies that are struggling to gain access to credit, economists said.

Italy Concern

Every Group of Seven central bank bar the U.S. Federal Reserve meets this week amid speculation that weak growth and inflation will keep monetary policy loose in advanced economies.

The Bank of England held its bond-purchase program at 375 billion pounds ($565 billion) and kept its key rate at 0.5 percent today. The Bank of Japan — set for a change in leadership — left an asset-purchase fund unchanged at 76 trillion yen ($810 billion) and rejected a call for an immediate start to open-ended buying.

Bank of Canada officials said yesterday that their 1 percent rate is likely to be “appropriate for a period of time.”

Italian bond yields surged after anti-austerity parties led by former Prime Minister Silvio Berlusconi and comedian-turned- politician Beppe Grillo won about 55 percent of the vote in last month’s election.

‘Send a Warning’

That’s raised questions about whether the ECB would step into the breach if market turmoil escalated, threatening the economic recovery. The ECB’s as-yet-untapped bond-purchase program, known as Outright Monetary Transactions, can only be activated if a country requests aid from Europe’s rescue fund and agrees to reforms.

“I expect the ECB to send a warning in Italy’s direction that there won’t be any softening of the conditions attached to the OMT,” said Christian Schulz, senior economist at Berenberg Bank in London. “Draghi will reiterate the conditions agreed upon in September and imply that Italy shouldn’t turn to the ECB for help.”

Still, increased uncertainty is beginning to show in the survey indicators on which Draghi has built his expectations for a gradual recovery in the second half of the year. European investor confidence declined this month for the first time since August, the Sentix Institute said on March 4, and a gauge of manufacturing and services output worsened.

ECB Projections

The ECB will probably revise down its growth and inflation forecasts to reflect a worse-than-predicted economic contraction in the final quarter of 2012 and the euro’s appreciation at the beginning of this year, said Anders Svendsen, an economist at Nordea Bank AB in Copenhagen.

The ECB’s staff currently predicts the 17-nation euro economy will contract 0.3 percent this year before growing 1.2 percent in 2014. Inflation is seen averaging 1.6 percent this year and 1.4 percent next year.

“The staff projections are weak enough to justify a refi- rate cut if the ECB wants to cut, but the ECB probably believes that the benefits will be too small,” Svendsen said. “We expect no outright signals of more rate cuts at this point.”

ECB council member Christian Noyer said last month there is “no particular interest in cutting rates by a few cents if it only impacts Germany or core countries.”

Business confidence in Germany, Europe’s largest economy, jumped to a 10-month high in February. Still, factory orders unexpectedly fell in January, a report showed today.

Policy Transmission

Economists surveyed by Bloomberg predict the benchmark rate will stay unchanged through the second quarter of next year as officials remain preoccupied with fixing the transmission channel of monetary policy.

Draghi told lawmakers in Brussels last month that “the number-one challenge” at the moment is to ensure that ultra-low interest rates are feeding through to the economy.

Banks have started to repay the ECB’s three-year loans, or Longer Term Refinancing Operations, which were designed to prevent a credit squeeze and encourage lending. That’s pushed up borrowing costs in financial markets and sparked concern about a premature tightening of monetary conditions.

The rate on three-month Euribor futures expiring in December rose to 0.575 percent on Jan. 28, the highest since the beginning of July. It fell to 0.255 percent yesterday.

‘More Funding’

“The president might hint that the ECB could provide even more funding to those in need through extra long-term LTROs in future,” said Jennifer McKeown, senior European economist at Capital Economics in London. “He might also say more about ways for the bank to circumvent the persistent weakness of bank lending and get funds to firms and households directly.”

At the same time, concern about the side-effects of expansionary policy is growing at the ECB. Executive Board members Peter Praet and Yves Mersch last week warned of the risks in leaving emergency stimulus in place for too long.

“If we look at recent comments from the board, they say there are signs of stabilization, green shoots, they speak about a nascent recovery,” said Nick Matthews, senior euro-area economist at Nomura in London. “It would require severely weaker projections that challenge the recovery or its strength for the ECB to act.”

© Copyright 2022 Bloomberg News. All rights reserved.

The European Central Bank left interest rates on hold as it gauges how big a threat Italy poses to the economic recovery.
Thursday, 07 March 2013 07:56 AM
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