ECB ready to act to counter unwarranted money market rates

The European Central Bank said on Thursday it was ready to cut interest rates or pump more money into the euro zone economy if necessary to bring money market rates down and help the euro zone's economic recovery.

 

The bank left its key interest rate unchanged at 0.5%, as expected by all 60 economists polled by Reuters.

 

But ECB chief Mario Draghi said the policymaking Governing Council did discuss a possible rate cut at its monthly meeting, partly due to concern about money market rates and the uncertain "very green" nature of the recovery.

 

"If money market developments were to be judged unwarranted in their impact on our assessment of medium-term inflation, then such an instrument should be considered," he told a news conference.

 

An ECB statement said the bank would remain "particularly attentive" to the implications of shrinking excess liquidity in the euro area on its monetary policy stance.

 

The ECB shaved its forecast for euro zone growth next year to 1.0% from 1.1% in the June staff projection and said the 17-nation currency area's economy would contract by 0.4% this year, less than the 0.6% foreseen three months ago.

 

Draghi reaffirmed the central bank's commitment to keep interest rates low for a prolonged period. Abandoning its tradition of never pre-committing on future moves, 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.

 

However, the move has failed to bring down market rates - a task made all the harder for Draghi by the fledgling recovery and a looming Federal Reserve meeting later this month, at which the U.S. central bank could begin to unwind U.S. stimulus.

 

Draghi said there had been a debate on a rate cut on Thursday, with some governors arguing that improving economic data made such a discussion unjustified while others said the recovery was too fragile to rule out such a move.

 

"Output is expected to recover at a slow pace, in particular owing to a gradual improvement in domestic demand supported by the accommodative monetary policy stance," the ECB said. But it noted that the main risks remained on the downside.

 

Recent economic data has come in relatively strong, largely validating the ECB's main scenario of a gradual recovery taking hold in the second half of this year and gathering pace in 2014.

 

CONSTERNATION

 

However, a rise in forward market interest rates has already caused consternation among the bank's policymakers. Draghi cautioned last month that market expectations of an interest rate rise are "unwarranted".

 

Market rates have continued to rise despite the warning and the ECB's July assurance - repeated in August - of long-term low interest rates.

 

Benchmark 10-year German bond yields hit an 18-month high above 2% ahead of the meeting of the ECB's policymaking Governing Council, due to an improving economic outlook.

 

Much of the market rate pressure is linked to the global impact of the Federal Reserve heading towards cutting back its stimulus programme - a dominant factor in global finance.

 

But divergent nuances among policymakers on what the ECB's first stab at forward guidance actually meant has diluted its impact and analysts said the central bank's main challenge was to make it more credible instead of lowering interest rates.

 

In a fresh sign of how difficult it is for the ECB to frame a single monetary policy for widely divergent economies in the 17-nation euro zone, the Ifo institute said Germany's current account was likely to hit another record surplus this year.

 

The surplus, projected to reach 7.2% in 2013, above the European Commission's recommended ceiling of 6%, underlines persistent economic imbalances in the euro area, with exports from the bloc's biggest economy continuing to boom.

 

Euro zone businesses had their best month in over two years in August as orders increased for the first time since mid-2011, a survey showed on Wednesday, suggesting the region's economy will grow slightly this quarter after 0.3% growth in the second.

 

In one encouraging sign for the ECB, the interest rates that banks charge companies in debt-ridden southern Europe are falling more than in core euro zone nations, even as the gap between them remains wide.

 

Widely varying borrowing costs across the 17-country bloc have developed into a major headache for the central bank, which charges banks a flat 0.5% interest rate for loans.

 

In July, the interest small businesses have to pay fell most in the debt-ridden countries and the central bank's measure of country-by-country variation fell to its lowest level since August last year.

 

However, the amount of money euro zone firms borrowed fell at its fastest pace since the inception of the euro in July.