ECB sharply cuts forecasts as economic outlook deteriorates

The European Central Bank slashed its forecasts for growth and inflation over the next two years, saying the outlook had deteriorated since its last staff forecasts were published in September.

The bank also kept the cost of borrowing at record lows after it met today and said it would make a decision on further stimulus early next year.

That disappointed some traders who had bet that Thursday’s meeting would bring details of additional measures, possibly a US-style government bond-buying scheme, seen as strongly supportive for the equity market.

ECB president Mario Draghi said the bank would reassess the impact of its recent policy measures early in 2015, though not necessarily in January, and take further action - including such quantitative easing - if needed. "Investors were hoping for more substance on sovereign bond purchases, but Draghi hasn't given investors anything that is really new," said John Smith, senior fund manager at Brown Shipley.

With recovery stalled across many of the 18 countries that share the euro, Frankfurt forecast 2014 inflation at 0.5 per cent, rising slightly to 0.7 per cent next year and 1.3 per cent in 2016. It also cut its prediction for economic output in the euro zone to 0.8 per cent this year, 1.0 per cent in 2015 and 1.5 per cent in 2016.

In September, the ECB had predicted that inflation would be 0.6 per cent this year, then rise to 1.1 per cent and 1.4 per cent in 2015 and 2016 respectively. It had also forecast in September that gross domestic product would grow by 0.9 percent this year and by 1.6 per cent and 1.9 per cent in 2015 and 2016 respectively.

By lowering its forecasts, which show how the ECB expects the economy to develop, the euro zone central bank will heighten expectations that it will take further steps to bolster the bloc’s flagging economy.

ECB president Mario Draghi recently threw the door open for drastic measures to prevent growth and inflation from sliding further and expectations are rising that a move could come as soon as the first three months of next year

While a perceived lack of detail caused investors to cash in recent stock market gains, many still believed the ECB would announce sovereign bond purchases next year.

Mr Draghi said technical preparations for further stimulus measures were being stepped up.

At Thursday’s meeting, the ECB left its main refinancing rate, which determines the cost of credit in the economy, at 0.05 per cent. It also kept the rate on bank overnight deposits at -0.20 per cent, which means banks pay to park funds at the central bank.

Mounting concerns about the euro zone economy were underlined by the US Federal Reserve’s influential vice chair, Stanley Fischer, who said that money-printing would help Europe as it had the United States.

“If the ECB moves in that direction, it will have positive effects,” Mr Fischer, who was Mr Draghi’s academic mentor at university, told a newspaper in Italy.

Mr Draghi faces considerable political obstacles to taking this step, chiefly from a reluctant Germany.

Last week, Sabine Lautenschlaeger, Germany’s appointee to the ECB’s executive board, said now was not the time for state bond buying. So while the ECB could extend a scheme to buy secured debt to include corporate bonds, it is unlikely it will announce any money printing to buy government bonds.

Economists, roughly half of whom expect the bank to start buying government bonds - a step that should buoy the economy when banks exchange bonds for ECB cash - have pencilled this in for the first three months of next year. ECB vice-president Vitor Constancio has said the bank will be better able to gauge then whether it needs to take the ulitimate policy step.

Other major central banks including the Fed, Bank of Japan and Bank of England, have already used quantitative easing to stimulate their economies. But divisions between debt-shy euro zone countries such as Germany and southern states including Greece make such a step more difficult for the ECB. Germany, the bloc’s biggest economy by far and its most influential, fears it would encourage reckless borrowing.

Reuters