Euro zone economy ‘on track’ for a slow recovery

The euro zone economy remains on track for a slow recovery, European Central Bank president Mario Draghi said today, reiterating the ECB's pledge to keep interest rates low for now.

“Real GDP growth in the second quarter was positive after six quarters of negative output growth and confidence indicators up to September confirm the expected gradual improvement in economic activity from low levels,” he told a news conference in Paris after the bank had left interest rates unchanged.

The ECB has grown concerned about market interest rates, which moved higher over the summer at the prospect of the US Federal Reserve unwinding its stimulus.

Seeking to guide them down, the ECB said in July it would keep its rates at current or lower levels for an “extended period”, its first use of forward guidance.

The ploy struggled to gain traction until the Fed last month delayed unwinding its stimulus. Investors will gauge how dovish Mr Draghi sounds after the decision to leave the ECB’s main interest rate at 0.5 per cent.

The central bank also left the rate on its deposit facility at 0.0 per cent and held its marginal lending facility - or emergency borrowing rate - at 1.00 per cent.

“This is as expected,” Berenberg bank economist Christian Schulz said of the rate decision. “The economy is recovering, there is little pressure to cut rates at the moment. At the same time, inflation is low and plenty of downside risks are out there, so there is no pressure to tighten policy quickly.”

Mr Draghi said the euro zone and its currency are in better shape than they were, and less susceptible to political instability in countries like Italy, Portugal and Greece.

Asked about the recent political problems in Italy, Mr Draghi said he would only speak in general terms, but that while such instability could cause local economic problems, it did not spread to the region as a whole. “It doesn’t really hurt the foundation of the euro zone as it used to do a few years ago,” he told a news conference in Paris. “The euro zone and the euro (are) more resilient than (they were) a few years ago.

He said the ECB’s pledge to provide funds in some circumstances to countries in difficulty had helped. “(Also) the governance of the euro area has progressed significantly,” he said.

Mr Draghi said he expected no disasters to come to light in forthcoming financial health checks on the region’s banks, which would be rigorous.

The ECB is scheduled to take over supervision of the banks in about a year, and a resolution mechanism to deal with problem lenders should follow in 2015. Before that, the central bank of the 17-member euro zone is to conduct an asset quality review, followed by stress tests, to ensure that banks enter common supervision in good health.

Mr Draghi said a backstop needed to be in place to handle potential fallout from the twin reviews, and added that details of the test procedure would be given later this month.

“The whole exercise of the asset quality review and the balance sheet assessment and the stress tests make sense only if they are credible,” Mr Draghi said. “...I don’t expect major disasters, but it’s quite important that full light be shed and full transparency be there,” he told a news conference after the ECB left interest rates unchanged. Asked about the state of the Spanish banking sector, Mr Draghi said that the country had made good progress in fixing its banks after it applied for aid from its European partners. “Everything seems to suggest that Spain will approach this exercise well-equipped, but of course it is very difficult to guess what will happen with individual banks,” he said.

Last week, Mr Draghi underlined the ECB’s readiness to act, saying that, if needed, it could use another LTRO - ultra-long loans it issued in late 2011 and early 2012 to pump over €1 trillion into the system.

Excess liquidity - the amount of money beyond what the banking system needs to function - has fallen to €221 billion from over €800 billion early last year, approaching a level expected to push market rates closer to the ECB’s main rate.

The excess has fallen as banks repay the LTROs they took from the ECB in late 2011 and early 2012 and the ECB is concerned that higher short-term market rates that banks use when lending to each other could hurt the euro zone’s recovery and push inflation further below target.

(Reuters)