ECB to Wait and See

European Central Bank (ECB) President Mario Draghi said the ECB could take action to counter low inflation as soon as next month, when more data on the euro area's economy will be available.

“We are willing and we are ready to act,” Draghi said in Frankfurt today after the ECB left its benchmark interest rate on hold at a record-low 0.25 percent. “The reason for today's decision not to act has really to do with the complexity of the situation that I described and the need to get more information.”

The ECB will publish quarterly macroeconomic forecasts next month, including its first inflation prediction for 2016, which in the past have provided supporting evidence for further easing. Draghi is trying to guide the euro area through a fragile recovery and an extensive health check of the banking system, as well as negotiate the global market swings sparked by the U.S. Federal Reserve's decision to taper its own stimulus.

“The door to further steps remains wide open as headline inflation stays weak,” said Christian Schulz, senior European economist at Berenberg Bank in London. “If ECB staff come to the conclusion that inflation will stay significantly below target well into 2016, the ECB could go further and cut rates.”

The euro climbed the most in two weeks as Draghi spoke, rising as high as $1.362 from $1.35 at the start of the press conference. The yield on Germany's two-year government bond climbed about 5 basis points to 0.142 percent.

Inflation in the 18-nation euro area unexpectedly slowed to 0.7 percent last month, matching the slowest pace since 2009 and less than half the ECB's goal of just under 2 percent. The last time the figure was that weak was in October, when it contributed to a surprise November rate cut.

“We remain firmly determined to maintain the high degree of monetary accommodation and to take further decisive action if required,” Draghi said. “We firmly reiterate our forward guidance. We continue to expect the key ECB interest rates to remain at present or lower levels.”

Sterilization End

Draghi said that ending the absorption of crisis-era bond purchases to steer against money-market volatility is “one of the many instruments” that the Governing Council is looking at, without saying that it was discussed at this meeting. The ECB president has sought support from the Bundesbank in publicly backing the sterilization, which was introduced with the now-defunct Securities Markets Program to appease an inflation-wary German public.

Ending operations to soak up money created by purchases of bonds from Greece to Italy starting in 2010 would double excess liquidity in the system. That could help to curb volatility in market interest rates and reduce banks' incentive to keep cash at the ECB rather than lend it on. Draghi has said the Frankfurt-based institution is ready to act if money-market rates are unwarranted or the medium-term outlook for inflation worsens.

While swings in interbank borrowing costs have eased in recent days, Draghi said the central bank is still attentive. The rate that banks charge each other overnight, known as Eonia, fell to 0.13 percent on Feb. 4, the lowest level in a month. It surged as high as 0.36 percent on Jan. 20 and was above the ECB's benchmark for four straight days in January, the longest run since 2011.

Economic indicators have also improved. Gauges of euro-area manufacturing and German business confidence are at the highest levels in two and a half years. An ECB survey showed the region's banks expect to stop tightening corporate credit standards this quarter, a move that could help rekindle lending.

“Signs of improvement in activity are encouraging,” said Annalisa Piazza, a fixed-income analyst at Newedge Group in London. “This is one of the reasons behind today's 'wait and see' approach.”

The currency bloc's economy and financial markets have become more robust in the face of external risks such as the slowing of developing economies like China or Brazil and the Fed tapering, Draghi said.

“The euro-area economy and euro-area financial markets have shown a good deal of resilience,” Draghi said. “This is a modest recovery that is showing somewhat more encouraging signs.”

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

Your access to unlimited Treasury & Risk content isn’t changing.
Once you are an ALM digital member, you’ll receive:

Thought leadership on regulatory changes, economic trends, corporate success stories, and tactical solutions for treasurers, CFOs, risk managers, controllers, and other finance professionals
Informative weekly newsletter featuring news, analysis, real-world case studies, and other critical content
Educational webcasts, white papers, and ebooks from industry thought leaders
Critical coverage of the employee benefits and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor