ECB discusses rate cut, depicts bleak 2013

Reuters:The European Central Bank pondered an interest rate cut on Thursday and predicted the euro zone economy would shrink again in 2013, leaving the door open to a possible reduction in borrowing costs early next year.

ECB President Mario Draghi said the policymaking Governing Council held a wide discussion on interest rates before opting to leave them on hold. The euro fell against the dollar and the yen in response. The Council also touched on the idea of cutting its deposit rate into negative territory. By effectively charging banks for their deposits rather than paying them interest, the ECB could push banks to put their money to work elsewhere.

“There was a wide discussion ... but the consensus was to leave the rates unchanged,” Draghi told a news conference, a hint that opinions differed about what course to take. When there is unanimity, the ECB chief generally says so.

In the end, the ECB left its main interest rate at a record low 0.75 percent for the fifth month running despite new forecasts which suggest the euro area economy will contract next year as it has this. It left the deposit rate at zero.

On the idea of negative deposit rates, Draghi said: “We briefly touched upon the complexities that such a measure would involve and possible unintended consequences, but we didn’t elaborate any further.”

The bank’s new staff projections put gross domestic product in a range of falling by 0.9 percent to growing by just 0.3 percent next year, suggesting contraction is far more likely than not. Draghi said downside risks prevailed.

In September, the ECB’s staff had pencilled in a significantly higher range of -0.4 to +1.4 percent for the euro area economy.

“The somewhat downbeat ECB forecasts, the sombre tone of the ECB statement and Draghi’s admission that the ECB had a ‘wide discussion’ over many issues including a potential rate cut also keep the door open for a cut in early 2013,” said Berenberg Bank economist Holger Schmieding.

The Governing Council’s decision to leave its main interest rate unchanged for now matched economists’ expectations in a Reuters poll, which also showed opinion was split down the middle over the chances of a cut early next year.

“Later in 2013, economic activity should gradually recover as global demand strengthens and our accommodative monetary policy stance and significantly improved financial market confidence work their way through the economy,” Draghi said.

But a political impasse over the United States’ fiscal policy, which could presage steep tax hikes and budget cuts if a deal is not reached, could also dampen sentiment for longer, he said.

The level of uncertainty was reflected in the ECB’s first attempt to forecast 2014, for which it pencilled in growth of between 0.2 and 2.2 percent. The midpoint forecast for 2012 was pushed slightly lower to -0.5 percent. The ECB will also continue to supply euro zone banks with all the liquidity they ask for in the central bank’s refinancing operations at least until July 2013, Draghi said.

WAITING FOR SPAIN

While financial markets have calmed since the European Union and the International Monetary Fund put in place further steps to help Greece, and the ECB promised to do what it takes to preserve the euro, the bloc’s economy has sunk into recession from which it shows few signs of emerging soon.

An inflation forecast of 1.1 to 2.1 percent next year -- compared with the ECB’s target of close to but below two percent -- means there appears to be plenty of room to cut rates further.



But some at the central bank are wary of taking any action that could see the bloc’s governments soft-pedal on budget consolidation efforts. Others, it seems, feel the economy warrants more stimulus now.

Market interest rates vary greatly across the 17-country bloc and the ECB is focused primarily on fixing what it calls the ‘transmission mechanism’ for passing on its rates to all corners of the euro area before.

The most obvious way of doing that would be using the ECB’s yet to be used new bond-buying scheme, which could drive down government borrowing costs.

The ECB has not yet bought any sovereign debt under its new programme -- dubbed Outright Monetary Transactions (OMT) -- because Spain, which is seen as most likely to become the first country to make use of the new support measure, has not yet fulfilled the precondition of asking for help from the euro zone’s rescue fund.

Spanish Prime Minister Mariano Rajoy has said he wants assurances that ECB intervention would bring down Spain’s debt yields, Draghi refused to commit to any targets for bringing down Spanish borrowing costs.

“The conditions under which the OMT is going to be activated are very straight,” he said. “They don’t talk about negotiations or a certain interest rate or anything like that.”