Euro Zone Crisis

ECB holds benchmark rate as yields sink on bond plan

PUBLISHED : Thursday, 06 December, 2012, 6:44pm
UPDATED : Thursday, 06 December, 2012, 9:17pm

The European Central Bank kept interest rates on hold after its pledge to buy government bonds lowered borrowing costs and boosted confidence that the euro area can emerge from recession next year.

Policy makers meeting in Frankfurt today left the benchmark rate at a record low of 0.75 per cent, as predicted by 56 of 61 economists in a Bloomberg News survey. They also left the deposit rate at zero. ECB President Mario Draghi will hold a press conference to brief reporters on the decision and reveal new economic forecasts, including a first projection for 2014.

Italian and Spanish bond yields have plummeted since Draghi promised to do whatever it takes to save the euro and announced an unlimited bond-purchase program. That’s helping to ease the strain on the euro region’s third- and fourth-largest economies and fuelling optimism that the sovereign debt crisis can be contained, even after the 17-nation currency bloc slipped into recession.

“I expect solid growth for the euro area next year and no change in interest rates,” said Ulrich Kater, chief economist at DekaBank Deutsche Girozentrale in Frankfurt. “Only if the economy doesn’t grow might the ECB have to come up with a Plan B and lower interest rates.”

On Hold

The ECB will keep rates on hold into 2014, a separate survey of economists shows. A month ago, the median forecast was for a rate cut next year.

The Bank of England today left its key interest rate at 0.5 per cent and refrained from expanding its asset-purchase program.

The euro-area economy recorded a 0.1 per cent contraction in the third quarter, putting it back into recession three years after it emerged from the last one. Economists said the ECB is likely to cut its forecast for next year from September’s prediction of 0.5 per cent growth.

“The euro-area economy is worsening rapidly and that opens the door for rate cuts next year,” said Juergen Michels, chief euro-area economist at Citigroup in London. “We expect the ECB to lower its benchmark rate by two steps to 0.25 per cent next year.”

Economic Outlook

The European Commission on Nov. 7 forecast that the economy will contract 0.4 per cent this year and expand 0.1 per cent next year. Euro-area services and manufacturing output shrank for a 10th month in November, London-based Markit Economics said on Thursday.

At the same time, the commission’s gauge of economic confidence unexpectedly rose in November after euro-area finance ministers eased the terms of Greece’s bailout to keep it in the monetary union.

Spain’s 10-year bond yield dropped to 5.25 per cent this week, the lowest since March, and Italy’s fell to a two-year low of 4.42 per cent.

While the ECB may predict economic stagnation or even contraction next year, it will forecast growth of about 1 per cent for 2014, said Marco Valli, chief euro-zone economist at UniCredit Global Research in Milan. The bank is unlikely to estimate inflation rates significantly below its 2 per cent limit, Valli said.

German Concerns

“Although the recovery will be slow to gain momentum, the inflation projection at the policy-relevant horizon is going to be in line with the central bank’s definition of price stability,” he said. “We continue to forecast a steady refinancing rate for the foreseeable future, although the ECB’s easing bias is going to remain in place for several months to come.”

German inflation fears may also make policy makers think twice about cutting rates.

Bundesbank President Jens Weidmann was the only member of the ECB’s Governing Council to vote against Draghi’s bond- purchase plan, known as Outright Monetary Transactions, saying it is tantamount to printing money to finance governments and warning of the risk that it could fuel inflation.

Draghi has reiterated that the ECB stands ready to activate the program as soon as a country like Spain fulfills the pre- requisites of seeking aid from Europe’s bailout fund and signing up to conditions. At the same time, he’s sought to placate German concerns with assurances that the purchases won’t fuel inflation.

“A rate cut could further undermine support of inflation averse Germans and thus be counterproductive,” said Christian Schulz, senior economist at Berenberg Bank in London. “It is pivotal for the ECB to ensure strong OMT credibility. This means ensuring a maximum of support from Germany.”