News Column

ECB to Hold Rates Low for an Extended Period

July 5, 2013

Andrew McCathie

European Central Bank

The European Central Bank acted on Thursday to bolster the eurozone's chances of economic recovery by announcing plans to keep interest rates at record low levels for an extended period, while raising the prospect of further reductions.

The Frankfurt-based bank will retain rates "at present or lower levels for an extended period of time," ECB chief Mario Draghi told a press conference, after it left borrowing costs unchanged at their historic low of 0.5 per cent.

"The tightening of global money and financial market conditions ... may have the potential to negatively affect economic conditions," Draghi said.

The ECB's unprecedented announcement that it was joining other major central banks in introducing forward guidance on interest rates came shortly after the Bank of England unveiled a similar policy aimed at stabilizing financial markets and heading off threats to the economy.

The move represents a major shift in policy for the ECB, which had previously insisted that it did not "precommit" on the future direction of borrowing costs in the 17-member eurozone.

But a sudden tightening of global monetary conditions and renewed market turbulence following the US Federal Reserve's announcement last month that it was considering scaling back its stimulus programme appears to have forced the ECB's hand.

"What was expected to be a rather dull meeting, turned out to be historic," said ING Bank economist Carsten Brzeski.

"With forward guidance for the first time ever and further rate cuts in sight, the ECB is trying to use its 'whatever-it-takes' policy to safeguard the fragile recovery of the eurozone," Brzeski said.

Almost a year ago, Draghi managed to swing sentiment around in previously sceptical financial markets by declaring the ECB would do "whatever it takes" to save the euro.

Draghi told reporters that a very significant step forward had been taken, adding that the ECB's decision followed signs of subdued inflationary pressures and would inject a downward bias for interest rates.

The ECB met against the backdrop of renewed market tensions in the eurozone, with a political crisis in Portugal and worries about Greece meeting the conditions of its bailout.

"Portugal has achieved very remarkable results," said Draghi. "It has been a painful route."

Most economists had expected the ECB to keep its benchmark refinancing rate on hold at 0.5 per cent, possibly until the end of 2014. The Washington-based Federal Reserve also has a policy of forward guidance.

The ECB's pledge on rates sent blue-chip eurozone shares higher by 3 per cent. The euro, however, slumped by 0.8 per cent to 1.2908 dollars.

Draghi declined to spell out exactly what the bank meant by an extended period of time.

He went on to say that 0.5 per cent did not necessarily represent the floor for the cost of money in the eurozone.

Weak economic activity means the ECB sees inflation in the eurozone averaging 1.4 per cent this year and 1.3 per cent next year, which is well below its target of keeping annual inflation at below - but close to - 2 per cent in the currency bloc.

Analysts believe that this could give the bank room to trim rates again if the ECB's forecast of a recovery in the region later in the year fails to materialize.

Unlike the Fed, however, the ECB was preparing to pull back from the loose monetary policy it has launched to help revive the eurozone economy.

Draghi said the bank's bond-buying programme - the so-called Outright Monetary Transactions (OMT) - would remain an effective weapon in the fight to restore economic confidence in the eurozone.

"The OMT is ready to be activated," he said. "It's an effective backstop."

Source: Copyright 2013 dpa Deutsche Presse-Agentur GmbH

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