The European Central Bank left interest rates on hold as the debt crisis tightens its grip on the euro-area economy, increasing pressure on policy makers to deliver further stimulus.
ECB officials meeting in Frankfurt on Wednesday kept the benchmark interest rate at a record low of 1 per cent, as predicted by 49 of 60 economists surveyed by Bloomberg News. Ten forecast a quarter-point reduction and one a half-point cut. With European governments struggling to fix a crisis that’s engulfing Spain and could force Greece out of the euro, economists say the ECB may soon be forced to lower rates and introduce more liquidity support for banks.
The Group of Seven nations yesterday agreed to coordinate their response to Europe’s turmoil, which has tipped at least eight of the 17 euro-area economies into recession and damped European demand for foreign goods. ECB President Mario Draghi, who said last week the monetary union is “unsustainable” in its current form, could choose to withhold further stimulus until governments do more to tackle the causes of the crisis.
“There is justification for a rate cut now solely on the economic data from the last few weeks,” said Christian Schulz, an economist at Berenberg Bank in London. At the same time, “a move in July is more likely as it will come after the Greek elections, the French parliamentary elections and the European summit. There’s more chance then that governments will have done something.”
Draghi held a press conference at 2:30 pm, when he will unveil the central bank’s latest economic forecasts. European Central Bank officials convened a day earlier than usual due to a public holiday in some German states tomorrow.
G7 finance ministers and central bankers discussed “progress toward financial and fiscal union in Europe” on a conference call yesterday that focused on Spain and Greece, officials said.
European representatives “said they will speed up their efforts to resolve those problems, which was encouraging to us,” Japanese Finance Minister Jun Azumi told reporters in Tokyo, adding “Japan is ready to provide support if there is anything we can do.”
The Reserve Bank of Australia cited Europe’s crisis when cutting its benchmark rate yesterday by a quarter point to 3.5 per cent, while the Bank of Canada held its key rate at 1 per cent. The Bank of England will announce its latest policy decision tomorrow amid speculation it could increase asset purchases after the UK slipped back into recession.
European Central Bank in March predicted an economic contraction of 0.1 per cent for 2012 and growth of 1.1 per cent for 2013. Inflation was projected to average at 2.4 per cent this year and 1.6 per cent next. Economists said they expect modest downward revisions to both the inflation and growth outlooks on Wednesday.
“The ECB might want to wait for further corroborating data to conclude that its second-half-of-the-year recovery expectations are challenged,” said Silvio Peruzzo, an economist at Royal Bank of Scotland in London. “We do not exclude the possibility that the ECB might pre-announce it this week, recognising the increasing downside risk to the economy.”
While the euro region narrowly avoided recession in the first quarter, latest data suggest the economy is shrinking again.
Unemployment has reached 11 per cent, the highest level on record, and purchasing manager indexes show manufacturing and service industries are contracting at a faster pace than they were when the ECB last cut rates in December.
International Monetary Fund Managing Director Christine Lagarde said in an interview with Sweden’s Svenska Dagbladet published June 4 that it’s “clear” the ECB has room for another rate cut.
Economists said Draghi is likely to announce on Wednesday an extension of the ECB’s policy of full allotment in its refinancing operations, which has been the main plank of its crisis response since 2008.
The ECB has also pumped more than 1 trillion euros ($1.2 trillion) in three-year loans into the banking system, and outgoing Executive Board member Jose Manuel Gonzalez-Paramo said in an interview on May 31 that the full effect of that measure has yet to be felt.
“We certainly expect Mario Draghi to underscore that the ECB has not run out of options yet,” said Elwin de Groot, senior market economist at Rabobank Nederland in Utrecht. “However, letting go now would remove any pressures on European policy makers to come up with a set of structural solutions to this sovereign debt crisis.”
US President Barack Obama has criticised European governments for not doing enough to arrest the crisis, now in its third year. Investor concern about political inaction drove Europe’s Stoxx 600 Index down 8 per cent last month, fully erasing gains this year, while the euro has plunged to a two- year low against the dollar. It traded at $1.24 on Wednesday.
Billionaire investor George Soros said on June 2 that European leaders, foremost among them German Chancellor Angela Merkel, have a three-month window in which to “correct their mistakes and reverse the current trends.”
Spain, which has resisted pressure to become the fourth euro-area nation to seek a bailout, yesterday called for the first time for European funds to shore up its banks.
The spread between Spanish and German 10-year bond yields widened to a record 5.4 percentage points last week and the cost of insuring against default on Spanish sovereign debt rose to a historic high.
Greece will meanwhile hold fresh elections on June 17 that could hand more power to parties opposed to the terms of the nation’s rescue package and precipitate its exit from the monetary union.
France will go to the polls over two rounds on June 10 and June 17 for elections to the National Assembly.
Further economic weakness or market tension “may convince the ECB to become more accommodative this summer,” said Nikolaus Keis, an economist at UniCredit Research in Munich. “While a rate cut and the options for the provision of further liquidity will most likely be discussed, the Governing Council is unlikely to reach consensus for immediate action.”
