May 8, 2014 10:24 pm

European Central Bank holds fire to await inflation forecasts

The map of Europe on the face of a two Euro coin©Reuters

Mario Draghi stirred expectations that the European Central Bank will finally act to stave off a lengthy period of low inflation that risks derailing the eurozone’s economic recovery.

The ECB president said on Thursday that there was “consensus” among policy makers that they were “not resigned to accept” low inflation, which at 0.7 per cent is a little over a third of the central bank’s target of just below 2 per cent. He also said the strength of the euro, which remains close to multiyear highs against the dollar, was a “serious concern”.

But the strong currency and weak inflation were not enough to force the ECB’s hand on Thursday. Rather than act now, governing council members wanted to wait and see the central bank’s new forecasts for inflation, which it will publish next month on the same day as its policy vote.

Many economists think that, after six months of mounting pressure, the ECB will finally ease policy then.

“What we heard strongly reinforces our prior view that the ECB will ease policy in June, with the new inflation projections a key trigger for action,” said Ken Wattret, economist at BNP Paribas.

“Mr Draghi has clearly presented a cliff hanger which makes it hard for the ECB not to come up with a brand new episode of monetary action at the June meeting,” said Carsten Brzeski, senior economist at ING Group in Brussels.

Inaction in June would risk significant market disappointment, as well as more criticism from governments, including France, and institutions such as the Organisation for Economic Co-operation and Development. However, it is by no means certain that the ECB will act.

The next set of central bank forecasts will almost certainly be lowered for this year on the back of months of weaker-than-expected inflation. But better news on growth could mean projections for 2015 and 2016 remain unchanged. And, because monetary easing takes time to work its way through to the economy, the governing council could view what happens after 2014 as more relevant for deciding whether or not to budge.

“The ECB will only act in June if new data and projections disappoint,” said Guntram Wolff, director of Bruegel, a Brussels-based think-tank.

Mr Draghi offered few clues on Thursday on what policy measures the ECB would take if it did ease in June, saying only that “all measures were discussed” during the meeting.

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However, comments by the ECB president last month suggest policy makers would cut rates to counter low inflation and a strong euro. Extreme measures, such as quantitative easing, remain unlikely.

“At today’s press conference, the ECB in effect made a move towards a rate cut,” said Jörg Krämer, chief economist at Commerzbank, though he cautioned that much would depend on data published in the coming weeks.

A cut to the benchmark main refinancing rate, which has stood at 0.25 per cent since last November, would send it to a fresh record low. More significant still would be for the ECB to go where no big central bank has gone before: cutting its deposit rate below zero – an experiment that so far only a very select group of central banks, such as Sweden’s Riksbank and Denmark’s National Bank, have tried.

Several policy makers, including arch-hawk and Bundesbank president Jens Weidmann, have said cutting the rate the central bank pays on deposits parked at the ECB into negative territory would be their preferred option to tackle the single currency’s appreciation.

The strength of the euro is viewed as one of the big factors for weak inflation because it makes imports cheaper.

If policy makers cut the deposit rate below zero to, say, minus 0.1 per cent, then banks would have to pay the central bank an equivalent rate on reserves parked overnight at the ECB. Policy makers hope the fee would discourage some investors from holding their money in eurozone banks and move their savings outside the bloc, which would help to lower the single currency.

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