ECB holds rates, leaves other tools on the shelf

Reuters: The European Central Bank left interest rates unchanged on Thursday and said it had discussed a raft of other policy options it could take if the Euro Zone economy does not emerge from recession later this year.

ECB President Mario Draghi said economic conditions did not warrant moves such as making banks pay to park their money with it overnight by taking the deposit rate into negative territory or cutting its main rate from a record low of 0.5%.

But these and other unconventional options, including very long-term loans to banks, measures to fire up the market for asset-backed securities (ABS) and tweaks to its collateral framework were ‘on the shelf’, Draghi said. “There was a common assessment that the changes that have taken place are not sufficiently one-directional as to grant action now,” Draghi told a news conference after the meeting. “Having said that, as I said before, we stand ready to act.”

While, a majority of 81 economists polled by Reuters had expected the 23-man Governing Council to keep rates on hold, the Euro hit near-one-month highs against the Dollar after Draghi ruled out negative rates. “There are really two key points that we are disappointed with. The first one is that he feels the economy doesn’t need negative rates right now and secondly there was some hope that he might discuss the option of asset backed securities, and that seems a long way away,” said Coutts strategist James Butterfill. “Despite improvement in PMIs recently, the economy is still very weak,” Butterfill added.

Purchasing managers index (PMI) surveys on Wednesday showed Euro Zone business activity shrank in May, but at a slightly slower pace. Downturns have eased in France, Italy and Spain, and Germany is stabilising, the data showed.

Stressing that ECB policy “will remain accommodative for as long as necessary”, Draghi nonetheless gave no indication that the bank was close to taking fresh policy action. The ECB slightly lowered its economic outlook for the Euro area this year, saying output would decline by 0.6% in 2013 but grow by 1.1% next year. ECB staff forecast inflation of 1.4% this year and 1.3% in 2014 – below the bank’s target of below but close to 2.0%.

Draghi pointed to some recent economic data as being better than expected and said ECB policy and exports would support a slow recovery in the Euro Zone economy later this year. “As regards any future policy measures, ECB President Draghi kept all options open but also tempered expectations about a quick ECB fix for the real economy,” ING Economist Carsten Brzeski wrote in a research note.

Warning to governments

Draghi kept up pressure on Euro Zone governments to reduce deficits and debt, saying more time should be given to correct excessive deficits only in exceptional circumstances.

His comments sounded critical of the European Commission’s decision last week to offer five countries more time to cut their budget shortfalls to within the EU’s limit of 3% of GDP, including a two-year extension for France. He also warned Euro Zone governments against expecting their borrowing costs, which have mostly fallen since the ECB presented its bond-buying plan last year, to remain low. “Don’t get too optimistic about the present market condition,” Draghi said. Yields on lower-rated Euro Zone bonds rose.

Seeking to calm markets, the ECB said last month it would offer banks all the funds they want at a fixed rate in its refinancing operations until July next year, which Draghi said on Thursday gave markets some ‘forward guidance’. “We haven’t addressed yet other types of forward guidance as other central banks have done and we are reflecting on it,” he added.

Other policy options could include moves to boost lending to SMEs, the economy’s backbone. The ECB has been studying this with the European Investment Bank – the EU’s soft lending arm – although Draghi said any action was “not for the short-term”. “There was no sense of urgency about more action at today’s press meeting,” said Anders Svendsen at Nordea.