Mario Draghi said the European Central Bank is “ready to act” as rising money-market rates threaten his drive to reassure investors that borrowing costs will stay low. Bond yields extended their gains.
“We will remain particularly attentive to the implications that these developments may have to the stance of monetary policy,” the ECB president said at his monthly press conference in Frankfurt today after the bank left its benchmark rate at a record low of 0.5 percent. “I’m very, very cautious about the recovery. I can’t share enthusiasm, it’s just the beginning. The shoots are still very, very green.”
Draghi is trying to convince markets that he will keep interest rates low for an extended period to support the euro area’s recovery from its longest-ever recession. Rate expectations have risen to levels that he described last month as “unwarranted,” suggesting some investors are questioning his pledge.
The comments failed to stop the advance in bond yields. German 10-year yields climbed to the highest level in 17 months, while those for top-rated Austria, Finland and the Netherlands climbed to the highest in more than a year. France’s borrowing costs at an auction were the most since President Francois Hollande was elected.
“Given today’s statements, one is left wondering why the ECB did not cut rates last month when Draghi characterized rate expectations as ‘unwarranted’,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG. “The press conference was slightly more dovish than we had anticipated, as the ECB is closer to a rate cut to counter rising forward rates.”
The overnight rate that banks expect to charge each other by the ECB’s August 2014 meeting, as measured by Eonia forward contracts, was at 0.31 percent at 5:45 p.m. in Frankfurt. That’s the level before Draghi’s promise on July 4 to keep rates low for an extended period. The rate has rebounded since falling to 0.09 percent by July 8. The euro slid as much as 0.3 percent to $1.3165 after Draghi’s remarks today.
Germany (GDBR10)’s 10-year yield rose 10 basis points to 2.04 percent, the highest level since March 2012. The French treasury sold 4.24 billion euros ($5.6 billion) of 2023 debt at an average yield of 2.57 percent, the highest at a 10-year auction since May 2012. Spanish and Italian yields also increased.
Excess liquidity in the eurosystem has dropped as banks have repaid three-year loans under the ECB’s longer-term refinancing operations, Draghi said. The measure has declined to 243 billion euros currently, from a high of 812 billion euros in March 2012.
The repayments “reflect improvements in financial market confidence, some reduction in financial market fragmentation and the ongoing deleveraging by euro area banks,” Draghi said. “Right now we view the current excess liquidity as adequate, but we remain ready to act.”
Draghi signaled that policy makers diverged on whether interest rates might need to be cut, saying that some governors “observed that improvement in the economy will not justify this discussion, but several other governors observed that, on the one hand, the recovery is still too green.”
The ECB today said the euro-area economy will shrink by 0.4 percent this year, an improvement from a previous prediction of 0.6 percent. It will expand by 1 percent in 2014, down from June’s forecast of 1.1 percent.
Inflation will be 1.5 percent this year, versus a prior forecast of 1.4 percent, Draghi said. He left next year’s estimate unchanged at 1.3 percent.
“The references to opinions on the Governing Council highlighted that there are divisions, but it seems that the dovish viewpoint is held more widely,” said Ken Wattret, chief euro-area market economist at BNP Paribas SA in London. “The assessment of the upturn in economic conditions was also rather cautious when set against the flood of improving data.”
The currency bloc’s economy will recover “at a slow pace,” Draghi said. “Our monetary policy stance will remain accommodative for as long as necessary, in line with the forward guidance provided in July. Risks continue to remain to the downside.”
The Bank of England today kept its bond-purchase target at 375 billion pounds ($587 billion) and maintained its key rate at 0.5 percent. Sweden’s Riksbank left its key repo rate unchanged at 1 percent for a fourth consecutive meeting.
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