Worried by Strong Euro, Draghi Says ECB May Act in June

Thursday, 08 May 2014 06:59 PM

 

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The European Central Bank is ready to take action next month to boost the eurozone economy if updated inflation forecasts merit it, its president said on Thursday, warning outsiders not to pressure the bank into action.

Stressing that the euro's strength was "a serious concern", ECB chief Mario Draghi said the exchange rate would have to be addressed, adding that the bank's policymakers held a discussion about "all instruments" at their meeting in Brussels.

Eurozone inflation ticked up to 0.7 percent in April from March's 0.5 percent, but remains far below the ECB's target of just under 2 percent, and Draghi said: "There is consensus about being dissatisfied with the projected path of inflation."

"The governing council is comfortable with acting next time but before we want to see the staff projections that will come out in early June," he told a news conference after the ECB left interest rates on hold, as expected.

Draghi did not specify what policy action the ECB could take beyond saying Thursday's council discussion touched on the policy instruments the central bank has mentioned previously.

These have included interest rate cuts, liquidity measures and even quantitative easing - central-bank speak for money printing to buy assets, a policy already pursued by the U.S. Federal Reserve, the Bank of Japan and the Bank of England.

"With today's press conference it will be hard for the ECB to take a 'mañana mañana' attitude," ING economist Carsten Brzeski said.

"With his comments on the exchange rate and hints at possible June action, Draghi has pushed the ECB into a corner from which it will be very hard to escape," Brzeski added.

The euro hit a 2-1/2 year high against the dollar while Draghi spoke before falling when he said the ECB was comfortable with taking action in June.

The ECB governing council met in Brussels against the backdrop of a Franco-German spat over ECB policy regarding the strength of the euro — one factor Draghi has identified as a potential trigger for policy action.

"The strengthening of the euro in the context of low inflation and still low levels of economic activity, is a cause for serious concern in the view of the Governing Council," he said.

But Draghi pushed back against the countries — led by France — and institutions that have been urging the ECB to take action to boost the economy and counter low inflation.

"We have received plenty of advice," he said. "We are independent, so people should be aware that if this might be seen as a threat to our independence it could cause long-term damage to our credibility."

 

 

QE "SOME WAY OFF"

Thursday's strong signal that the ECB is ready to act in June will heighten speculation about just what the ECB could do.

Draghi raised the idea in an April 24 speech of a "broad-based asset purchase programme" if the inflation outlook worsens. But just a few days later — at a meeting with German lawmakers — he played down the prospect of QE any time soon.

The ECB chief did see "a problem of ongoing low inflation rates, which could lead to measures", a source who attended the meeting said, adding: "He mentioned quantitative easing in this context but made clear that we're still some way off QE."

A far more likely scenario is a cut in rates — both in the ECB's main refinancing rate and perhaps in its deposit rate.

Cutting the deposit rate into negative territory from zero would see the ECB effectively charge banks for holding their money overnight - a move that, in theory, would encourage them to lend more money out to businesses and households.

Several ECB policymakers have signaled that a cut in the deposit rate into negative territory is their preferred measure for dealing with strength in the euro, as it would make euro-denominated assets less attractive.

While the ECB is far from embarking on a broad asset-buying plan, it is closer to readying a targeted funding operation that would seek to encourage banks to lend to small and medium-size businesses, or SMEs.

Such an operation could see the ECB offer banks cheap, long-term loans, or LTROs, in return for collateral in the form of bundled loans to SMEs — a ploy that would aim to support the market for SME loans packaged as asset-backed securities (ABS).

If banks responded to the offer, such a measure could give the smaller companies that form the backbone of the eurozone economy better access to credit and allow ECB policy rates to filter through to them more efficiently.

Berenberg bank economist Holger Schmieding said full-scale QE looked unlikely but that other, smaller measures — like a modest rate cut, a targeted LTRO, or purchases of some non-sovereign securities — would have little impact.

"They may lead to a decline in the exchange rate by, say, a couple of cents, for a couple of weeks," Schmieding said.

© 2014 Thomson/Reuters. All rights reserved.

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