ECB keeps interest rates unchanged

The European Central Bank has kept rates on hold for the fourth month in a row despite inflation running at less than half its target.

The decision came as the ECB said it expects consumer price rises to accelerate slowly over the next three years, but still undershoot its target of close to, or at, 2 per cent by the end of 2016.

The central bank’s outlook, its first to extend two years ahead, also anticipates economic output to be slightly higher than its previous forecasts in December.

The ECB expects euro zone inflation to increase only slightly this year to 1 per cent, and for price rises to accelerate to 1.3 per cent in 2015 and 1.5 per cent in 2016. Mario Draghi, ECB president, added that in the fourth quarter of that year inflation would be 1.7 per cent.

He roughly estimated that euro zone inflation had been reduced by about 0.4 or 0-5 percentage points as a result of the stronger exchange rate against the dollar.

The central bank said that it expects gross domestic product growth of 1.2 per cent this year, compared with 1.1 per cent in earlier forecasts, 1.5 per cent in 2015 and 1.8 per cent in 2016.

The governing council yesterday voted for the central bank’s benchmark main refinancing rate to remain at a record low of 0.25 per cent, where it has been since November. The rate paid on lenders’ deposits parked at the central bank stayed at zero.

Mr Draghi said interest rates would “remain at present or lower levels for an extended period” maintaining the central bank’s “forward guidance” policy. He said that the ECB’s “baseline scenario” for the economy remained unchanged with signs of stabilisation of the currency bloc underlined by recent data. He added that concerns outlined in last month’s press conference, namely, a change in the inflation outlook or stress in money markets, had not materialised.

Output gap
But in a fresh line for the ECB, Mr Draghi said that the "slack" in the economy was a topic of much discussion at the governing council meeting, adding that the size of the so-called output gap (the difference between what an economy is producing and what it is capable of producing at full potential) meant that monetary policy would remain accommodative "even after" the economy has picked up.

The decision to hold firm was widely touted by economists. Though inflation, at 0.8 per cent, continues to grossly undershoot the central bank’s target, better data on the euro zone’s economy over recent weeks had trimmed expectations of a cut.

Given economists had been expecting the forecasts to show inflation still missing the ECB’s target in the year after next, some thought this could be used to justify measures to inject liquidity into the currency bloc’s banking system.

One option identified was for the central bank to halt the sterilisation of its prior purchases of government bonds made through its crisis-fighting securities markets programme. Sterilisation in effect removes the liquidity that has entered the system via the central bank’s debt purchases.

However, Mr Draghi said that while this had been on the ECB’s list of policy actions, money market conditions had not justified such action and that the effects of this would be limited anyway.

Markets sent the euro as high as $1.3817 as the press conference got under way, as it interpreted the fresh inflation and growth forecasts to suggest the ECB may not be a hurry to further loosen monetary policy soon. – (Copyright The Financial Times Limited 2014)