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Europe, Forex

ECB opens door to rate cuts, more bond buys

* Rates unchanged

* Rate guidance changed

* Draghi speaks at 1230 GMT

* Draghi leaves office Oct. 31 (Updates with rate decision)

By Balazs Koranyi and Francesco Canepa

FRANKFURT, July 25 (Reuters) – The European Central Bank opened the door to rate cuts and the restart of bond purchases on Thursday, aiming to prop up confidence in a bloc which has struggled with a manufacturing recession that risks unravelling years of stimulus.

The ECB, which kept interest rates unchanged for now, said it saw rates at present or lower levels through mid-2020, giving up a previous pledge to keep rates unchanged through next June. It also tasked its staff to look at various other easing options.

With inflation stuck well below its target, industrial production in Germany, the bloc’s biggest economy, in a freefall and the U.S. Federal Reserve already in easing mode, it was only a matter of time before the ECB pulled the trigger. The biggest uncertainty was the sequencing of policy easing.

But having stoked easing expectations already, ECB President Mario Draghi was expected to deliver at least something on Thursday, even if more measures are likely to come later — possibly in September, when the ECB also releases fresh economic forecasts.

The ECB said easing options included a revamp of its forward guidance on interest rates, a tiered deposit rate and fresh asset purchases. In its statement, it also omitted its standard reference to its inflation aim of inflation rates “below, but close to, 2%” over the medium term.

It also emphasised that it considers its inflation target symmetrical, indicating it was willing to let price growth overshoot in future after a lengthy period of missing the target.

“If the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim,” the ECB said.

“It therefore stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner.”

While consumer confidence, employment and bank lending remain healthy, a recent string of industrial sentiment indicators paint a dismal picture, raising the risk that weak external demand, partly the result of a global trade war, could soon infect the domestic economy.

The euro eased on the ECB’s decision, trading at around 1.111 against the dollar at 1200 GMT compared with around $1.113 before the bank’s announcement.

Attention now turns to Draghi’s 1230 GMT news conference.

Expectations of new ECB stimulus have already driven down borrowing costs for euro zone governments, with the yield on Germany’s 10-year bond delving deeper into negative territory at -0.41%, close to a record low.

The case for ECB stimulus is supported by weak economic data, particularly in foreign trade and manufacturing, the engine of the euro zone economy’s recent growth run.

Indeed, the German Ifo institute warned earlier on Thursday that recession was spreading across all important sectors of German industry and sentiment was deteriorating quickly.

“There is far and wide nothing to be seen of the second half recovery hoped for in many places,” Commerzbank economist Joerg Kraemer said. “Germany is in a grey area between a marked growth slowdown and a recession.”

While some argue there is no urgency for ECB action, Draghi has just three months left of his eight-year tenure, giving him only a handful of opportunities to secure his legacy before he hands over to Christine Lagarde on Oct. 31.

Another problem is that whatever measure the ECB takes over the coming months, they all come with complications and have only limited potency given that the ECB has already exhausted much of its firepower.

Rates are already at record lows and the ECB’s balance sheet is equivalent to 40% of the block’s GDP, suggesting that the limits of its stimulus are near.

Buying more government bonds could also create problems for the bank as it is at or near its self-imposed limits in several of the 19 euro zone countries.

While policymakers say they have leeway to adjust their rules, critics of the bank’s asset purchases, who have already launched several legal challenges, are almost certain to take the ECB back to court. ( Additional reporting by Michelle Martin and Frank Siebelt Editing by Catherine Evans)

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