ECB holds rates as it waits for signs of recovery

The European Central Bank kept its main interest rate at a record low 0.5 per cent today, saying that improved economic data in May confirmed its forecast of a gradual recovery from prolonged recession later this year.

ECB president Mario Draghi told a news conference the bank's easy monetary policy "should continue to support prospects for an economic recovery later in the year" and it would remain "accommodative" for as long as necessary.

He also said the bank was still looking at ways to boost lending to small and medium-sized enterprises (SMEs) and revitalising the market for asset-backed securities but any action was “not for the short-term”.

The ECB slightly lowered its economic outlook for the euro area this year, saying output would decline by 0.6 per cent in 2013 but grow by 1.1 per cent next year. ECB staff forecast inflation of 1.4 per cent this year and 1.3 per cent in 2014 - below the bank’s target of below but close to 2.0 per cent.

Mr Draghi said the rate-setting governing council discussed at its monthly meeting the possibility of cutting the rate at which banks deposit money with the central bank to below zero.

The ECB was technically ready to do so but would keep this and other unconventional options “on the shelf” for now, he said.

Asked if the decision was unanimous, Mr Draghi said there was a consensus that “there wasn’t any direction change that would grant immediate action”. In the past, he has used the term consensus to signal a large majority rather than unanimity.

“This can be seen as a reaction to the slight improvement in the purchasing managers indices (PMIs), which seem to signal that the worst is over in the euro zone,” said David Kohl, chief economist for Germany at Julius Baer.

A firm majority of 81 economists polled by Reuters before yoday’s rate decision did not expect the ECB to cut its main refinancing rate or its deposit rate this month or in the near future.

Mr Draghi did not rule out further policy action if needed.

Purchasing managers index surveys yesterday showed euro zone business activity shrank in May, but at a slightly slower pace. Downturns have eased in France, Italy and Spain, and Germany is stabilising, the data showed.

Inflation, which fell to 1.2 per cent in April, rose back to 1.4 per cent in May, while Eurostat confirmed the region’s economy contracted by 0.2 per cent in the first quarter of the year.

“If data were to disappoint going forward, then a refi rate cut becomes an option,” ABN Amro economist Nick Kounis said.

European shares extended falls and peripheral bond yields rose as Mr Draghi spoke, after he cautioned against getting too optimistic about current market conditions.

Mr Draghi kept up pressure on euro zone governments to maintain the pace of deficit and debt reduction, saying that countries should be given more time to correct excessive deficits only in exceptional circumstances.

His comments sounded critical of the European Commission’s decision last week to propose more time for five countries to cut their budget shortfall to the EU limit of 3 per cent of GDP, including a two-year extension for France.

At last month’s post-rate decision news conference, Mr Draghi said the central bank would look at negative deposit rates “with an open mind and we stand ready to act if needed”.

But that might be ammunition the ECB wants to keep unused unless the economy enters a downward spiral.

“It’s not never-ever, but probably a lot would have to happen for it to happen,” ABN Amro’s Kounis said.

Other options could include moves to boost lending to SMEs, the economy’s backbone, although plans have not been finalised and Mr Draghi said he saw the European Investment Bank - the EU’s soft-lending arm - taking the lead.

Varying borrowing costs in different parts of the common currency area have developed into a major headache for the ECB, with firms and consumers in the debt-ridden south having to pay much higher interest rates than their counterparts in the north.

After months of hinting at action, the ECB has lately sought to temper expectations, warning against expecting a bazooka.

ECB Vice-President Vitor Constancio said last week that one should not “overblow” options the ECB has to repair the market for asset-backed securities, which could help access to funding when bank lending channels are blocked.

European Council President Herman Van Rompuy said today he expected a joint proposal with the European Investment Bank to improve SME financing this month, although the ECB seems content to be a junior partner in any such scheme.

Reuters