ECB holds rates despite deflation fears

Thursday 03 April 2014 17.53
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ECB President Mario Draghi said the central bank was ready to use all measures available to deal with low inflation
ECB President Mario Draghi said the central bank was ready to use all measures available to deal with low inflation
Key euro zone interest rate remains at 0.25% despite low inflation
Key euro zone interest rate remains at 0.25% despite low inflation

The European Central Bank has opened the door to turning on its money-printing presses to boost the euro zone economy and keep inflation from staying too low.

It kept interest rates steady at 0.25% its regular meeting, but afterwards ECB President Mario Draghi said he and his colleagues were committed to doing anything they could to stop low inflation from dragging on too long.

This included quantitative easing, the printing of money to buy assets, something that previously was considered highly undesirable by some euro zone central bankers, and only to be considered if prices were falling.

But policymakers have been willing in recent weeks to broach cutting deposit rates below zero – effectively charging banks to hold cash with the ECB - or embarking on QE if the threat of deflation became more acute.

"We will monitor developments very closely and we willc onsider all instruments available to us," Draghi said. "We are resolute in our determination to maintain a high degree of monetary accommodation and act swiftly if required."

He added: "The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too-prolonged period of low inflation."

That marked a significant shift of tone from last month when Draghi appeared to set quite a high bar to action.

The euro weakened against the dollar after his comments, hitting its lowest level since 28 February, but then recovered.

"The ECB is being slightly more dovish than the market expected," said Kathy Lien, managing director at BK Asset Management in New York. 

"The main takeaway is that the council is considering unusual techniques, and that's negative for euro/dollar."

Nonetheless some economists were sceptical that Draghi's words would soon be followed by action from the ECB.

"Our base case still is that the ECB is done easing and that major unconditional measures will not be taken, barring a major shock to the economy," said Holger Sandte, chief European analyst at Nordea.

ING referred to it as "The Art of Doing Nothing".

Euro zone inflation fell to 0.5% in March, levels last seen when the economy was deep in recession in 2009, but it was driven by the kind of softer food and energy prices the bank usually judges as temporary.

Draghi said the risk of deflation remained limited and labelled the latest inflation figures hard to read, partly because Easter holidays fall in April this year after coming in March last year, thereby delaying the impact of rising travel and hotel prices at a time when many people take a holiday.

"We need more information to assess whether there has been a change in the medium-term (inflation) outlook," he said.

One reason for the shift in thinking on QE - most notably from Bundesbank chief Jens Weidmann, often a hardliner – appears to have been the strength of the euro which will bear down on import prices, depressing inflation further.

Indeed, one aim of flagging possible future action could be to try and talk the currency down.

Draghi said the exchange rate was not a policy target but was a factor in assessing price stability, and gave it greater prominence in his introductory statement.

"The possible repercussions of both geopolitical risks and exchange rate developments will be monitored closely," he said.

Pressure from abroad to act has mounted, most notably from the International Monetary Fund, which has warned of the threat of "lowflation" rather than outright deflation.

"More monetary easing, including through unconventional measures, is needed in the euro area," IMF head Christine Lagarde said in a speech yesterday, outlining the Fund's policy recommendations ahead of its spring meetings next week.

Draghi conceded that low inflation made euro zone debt harder to cut and economic adjustment more difficult - though he also chided the IMF for making more forceful recommendations to the ECB than it did to the US Federal Reserve.

The OECD has also warned of the risk of deflation.

But buying government assets with newly created money is not an easy prospect for the ECB, and Draghi said that the central bank had not yet exhausted conventional means of stimulus.

It would have to decide how to spread the money between the bonds of different countries with varying credit qualities – and for this reason Draghi said that buying private-sector assets might have some advantages.

Draghi also pointed out that the euro zone depended more on bank lending than on capital markets, in contrast to the United States, which could limit the effectiveness of QE.