Bloomberg News

ECB Keeps Rates on Hold Amid Pressure for Cut

June 06, 2012

ECB Leaves Rates on Hold as Crisis Increases Pressure for Cut

ECB officials meeting in Frankfurt today kept the benchmark interest rate at a record low of 1 percent, as predicted by 49 of 60 economists surveyed by Bloomberg News. Photographer: Hannelore Foerster/Bloomberg

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 today kept the benchmark interest rate at a record low of 1 percent, 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.

“The central bank has very limited ammunition left and may have wanted to keep its powder dry,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. Still, “the ECB is likely to leave the door for rate cuts wide open in its press conference,” he said.

G-7 Concern

Draghi holds a press briefing at 2:30 p.m., when he will unveil the central bank’s latest economic forecasts. ECB officials convened a day earlier than usual due to a public holiday in some German states tomorrow.

G-7 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 percent, while the Bank of Canada held its key rate at 1 percent. The Bank of England will announce its latest policy decision tomorrow amid speculation it could increase asset purchases after the U.K. slipped back into recession.

New Projections

The ECB in March predicted an economic contraction of 0.1 percent for 2012 and growth of 1.1 percent for 2013. Inflation was projected to average at 2.4 percent this year and 1.6 percent next. Economists said they expect modest downward revisions to both the inflation and growth outlooks today.

“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, recognizing 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 percent, 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.

Room to Cut

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 today 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.

Pressure on Governments

“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.”

U.S. President Barack Obama has criticized 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 (SXXP) down 8 percent last month, fully erasing gains this year, while the euro has plunged to a two- year low against the dollar. It traded at $1.2490 today.

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.

Greek Elections

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.

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.”

To contact the reporters on this story: Jeff Black in Frankfurt at jblack25@bloomberg.net; Jana Randow in Frankfurt at jrandow@bloomberg.net

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


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