Central Bank Waits on Rates

WSJ: FRANKFURT—The European Central Bank kept interest rates steady despite a deepening downturn and slowing inflation, raising pressure on governments to take the lead in fighting Europe's escalating debt crisis.

ECB President Mario Draghi played down the severity of the euro bloc's economic troubles and debt woes, saying that the economy should gradually recover later this year. Europe's debt crisis is "far away" from the severity of the collapse of Lehman Brothers nearly four years ago, he said.

 

Still, Mr. Draghi opened the door to lower interest rates as soon as next month, saying the ECB stands "ready to act" if needed. "I don't think it would be right for monetary policy to fill other institutions' lack of action," he said after the ECB's monthly meeting, which occurred a day earlier than usual because of a public holiday Thursday in parts of Germany.

Officials voted to keep their main policy rate unchanged at 1% for a sixth straight month. The ECB said it would continue to offer banks unlimited loans, as expected, but otherwise announced no new lending measures.

 

"For the time being, the ECB is sitting on its hands as the bloc's economy and financial markets deteriorate further," said Nicholas Spiro, head of Spiro Sovereign Strategy.

 

Markets rallied Wednesday despite the lack of fresh ECB stimulus, focusing instead on hopes that the central bank will eventually do more to shore up Europe's flagging economy.

The ECB expects euro-zone gross domestic product to contract 0.1% this year and expand 1% in 2013, according to staff forecasts. Annual inflation should average 2.4% this year and ease to 1.6% in 2013—below the ECB's target of just below 2%—the ECB said.

 

Reports on Wednesday suggest the economy will contract this quarter after stagnating in the first quarter. Spanish industrial production slid 1.1% in April from March. German production plunged 2.2% from March. Germany has posted robust growth through much of the debt crisis that started more than two years ago, thanks in part to strong exports to the U.S. and fast-growing emerging markets such as China. But recent business surveys point to a sharply slower rate of expansion in coming months.

 

Mr. Draghi hinted that rate cuts could be on the way as early as July if the economy deteriorates further. Downside risks to the economy have "increased," he said, and "a few" ECB board members wanted a rate cut at Wednesday's meeting. A rate cut wasn't even discussed in May.

"They're taking a gradual approach, but they're open-minded about a rate cut," said Silvio Peruzzo, economist at RBS, who expects a rate reduction in July.

 

Following Mr. Draghi's remarks, J.P. Morgan moved its rate-cut forecast to July from September.

 

The ECB is the only major developed-region central bank with room to noticeably lower interest rates. The Federal Reserve, Bank of England and Bank of Japan all have rates closer to zero. Those banks have been more aggressive than the ECB in buying large amounts of government bonds and other securities to bring or keep market interest rates down.

Political uncertainty in Europe made a rate cut unlikely this month, analysts said. Greece holds repeat elections on June 17, with the outcome seen as critical to whether it receives continued financial assistance from international creditors in order to stay in the euro. At the end of June, European leaders will hold a summit that Mr. Draghi said he hopes will bring "clarification" to the vision they have for the euro over the next five to 10 years. He insisted that there is no quid pro quo under which the ECB would reward such steps with additional stimulus.

 

Another unresolved issue is how Spain deals with its troubled banks. Spain wants its banks to have the ability to directly access Europe's bailout fund for recapitalization money. But Germany is cool to the idea, preferring that any funds be channeled through the government.

 

Mr. Draghi signaled some reservations about having Europe's rescue fund, the European Stability Mechanism, directly recapitalize banks. "Do we really want an ESM that becomes a shareholder of banks?" Mr. Draghi said, noting that this would also require a change in the bailout fund's rules.

 

Lower ECB rates would provide some relief to Spain, Ireland and other peripheral economies where mortgages and other consumer loans are linked to official interest rates. But with rates already at record lows, any help would be marginal, analysts say.

Renewed purchases of government bonds could have an immediate effect—if done in large-enough quantities. But after €220 billion ($274 billion) in bond buys since May 2010, the ECB has mothballed the program for the past three months. Its rules forbid it from financing governments, making it hard to justify large-scale purchases. Mr. Draghi repeated past remarks that the program is "temporary" and "not infinite."

 

Mr. Draghi didn't rule out additional long-term loans to banks, but said more time is needed to gauge the effects of the previous two installments of three-year loans which totaled over €1 trillion.

 

The ECB head brushed off criticism that Europe's debt crisis is threatening the global economy, saying other countries have their own problems that they need to tackle, including "high and rising public debt."

 

"Europe may have some responsibility, but these countries have their own policy problems which are still unaddressed," Mr. Draghi said.

 

Write to Brian Blackstone