Bloomberg News

ECB Holds Rate Steady as Crisis Respite Gives Room to Pause Cuts

January 12, 2012

(Click on {Live <GO>} to watch Draghi’s press conference from 2:30 p.m. in Frankfurt.)

Jan. 12 (Bloomberg) -- The European Central Bank held interest rates steady after two straight cuts as signs of respite from the sovereign debt crisis gave it scope to pause.

ECB policy makers meeting in Frankfurt kept the benchmark interest rate at a record low of 1 percent, as predicted by 47 of 53 economists surveyed by Bloomberg News. ECB President Mario Draghi will explain the decision at a 2:30 p.m. press conference.

With the euro area on the brink of a second recession in three years, some signs of economic resilience have given the ECB room to assess the impact of its stimulus to date, which includes injecting a record amount of cash into the banking system. The central bank may be pressed back into action soon if looming budget cuts and a credit shortage prove too powerful for the economy to withstand.

“The ECB is taking a breather because it needs to see how its measures are feeding through and also keep politicians on their toes,” said Carsten Brzeski, senior economist at ING Group in Brussels. “It’s unlikely to rush into cutting rates below 1 percent, but it’s pragmatic enough to do so if the economy tanks.”

Positive Data

Data this week showed gains in German exports and French business confidence, suggesting the economic slowdown may be limited. The euro’s 10 percent drop against the dollar since late October and an easing of financial conditions may also provide support as leaders battle to restore investor faith in their region’s bond markets.

The Bank of England also refrained from announcing new stimulus today, maintaining its 275 billion-pound (421 billion) bond-purchase target and holding its key rate at 0.5 percent, as the U.K. economy shows some signs of robustness.

“We’ve had a couple of indications that things may not be as bad in 2012 as people expected them to be,” said Tobias Blattner, an economist at Daiwa Capital Markets who previously worked at the ECB. “The ECB has factored in this downturn that we’re seeing, which reflects the view that the recession won’t be a very deep one.”

German exports rose 2.5 percent in November from October and business confidence in Europe’s largest economy unexpectedly rose for a second month in December. A report last week showed that euro-area services and manufacturing output contracted less than initially estimated last month, led by Germany.

Borrowing Costs

In France, the second-largest economy in the 17-nation euro region, business sentiment climbed from a two-year low in December and industrial output increased in November.

Borrowing costs have also eased.

Italy sold 12 billion euros ($15.3 billion) of Treasury bills today, meeting its target. The rate on the one-year bills plunged to 2.735 percent from 5.952 percent at the last auction of similar-maturity securities on Dec. 12.

Spain sold 9.98 billion euros of bonds maturing in 2015 and 2016, twice the maximum target. The yield on a new benchmark bond, which matures in July 2015, was 3.384 percent, compared with 5.187 percent when Spain sold notes maturing in April 2015 at an auction in December.

During Draghi’s press conference “the key thing to look out for will be how the ECB assesses the recent signs of easing in some segments of financial markets and the stabilization of growth indicators,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan.

German Recession?

The economy is far from out of the woods.

German gross domestic product probably dropped 0.25 percent in the fourth quarter of last year from the third, the Federal Statistics Office said yesterday. Some economists predict another contraction this quarter, putting Germany into a technical recession.

Italian unemployment rose to 8.6 percent in November and consumer confidence fell to a 16-year low in December, while Spanish joblessness rose to a record 22.9 percent in November and industrial production recorded its biggest drop in two years. Greece is entering a fifth year of recession.

The ECB last month cut its 2012 growth forecast for the euro region to 0.3 percent from 1.3 percent.

While the median forecast in a survey of 21 economists is for the ECB to keep its key rate at 1 percent through mid 2013, Citigroup, JPMorgan Chase & Co. and Morgan Stanley all expect the benchmark to be cut to 0.5 percent by the middle of this year as recession bites.

‘Big Year’

“Beyond this week’s meeting, it will be a big year for the ECB,” said Greg Fuzesi, an economist at JPMorgan in London.

Concerned its ability to deliver price stability is under threat, the ECB has cut its key rate twice since Draghi took office on Nov. 1. It has also bolstered efforts to grease markets by lending banks an unprecedented 489 billion euros for three years and making it easier for them to borrow. It continues to buy the bonds of stressed sovereigns such as Italy.

The measures may be helping, handing governments breathing space to restore fiscal order and complete an overhaul of budget rules. The Bloomberg Euro-Area Financial Conditions Index has risen to minus 4 percent from a low of minus 5.4 percent in September.

The economy may also receive a fillip from a weaker euro.

Weaker Euro

The single currency has fallen almost 5 percent against nine developed-nation currencies in the past three months, according to Bloomberg Correlation-Weighted Currency Indices. ECB research shows a decline in trade-weighted terms of 10 percent adds 0.7 percent to growth in the first year and 1.2 percent in the second.

Stuttgart-based Daimler AG’s Mercedes-Benz is targeting higher car deliveries in 2012 after selling a record number of vehicles last year, Chief Executive Officer Dieter Zetsche said Jan. 5.

Risks remain as governments impose a fiscal squeeze that JPMorgan estimates could reach 2 percent of GDP. Greece has yet to seal a deal with bondholders over a proposed debt write-off on which fresh aid is contingent, and politicians are still wrangling over a revamp of budget limits.

Meanwhile, the ECB’s injections of cash are not finding their way to companies and households. Banks are instead hoarding the money and parking it back at the ECB. Overnight deposits at the central bank jumped to a record 486 billion euros this week.

Italy needs more help from the ECB to emerge from its “self fulfilling” liquidity crisis, David Riley, head of the sovereign-debt unit at Fitch Ratings, said today in Paris. The ratings company said Jan. 10 that it’s likely to make a decision on credit grades for euro-area nations that are under review by the end of this month.

“Europe is still in dangerous territory,” said Elga Bartsch, chief European economist at Morgan Stanley, who expects the ECB to eventually engage in more aggressive asset purchases known as quantitative easing. “But 2012 should also be the year in which the economy turns around.”

--With assistance from Jana Randow and Jeff Black in Frankfurt, Kristian Siedenburg in Vienna, and Simon Kennedy, Anchalee Worrachate and Harumi Ichikura in London. Editors: Matthew Brockett, Simone Meier

To contact the reporter on this story: Gabi Thesing in London at gthesing@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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