European Central Bank President Mario Draghi is under pressure to reveal Plan B.
A botched attempt to rescue Cyprus last month sent bank shares tumbling across the euro area and rattled confidence in policy makers’ ability to tame the sovereign debt crisis. With doubts growing about Draghi’s forecast for a second-half economic recovery, he’s considering his options.
They range from an interest-rate cut to a new round of long-term loans to banks, to a plan to encourage lending to companies, three officials with knowledge of the deliberations said. They stressed that such action may not be announced Thursday.
“They have to start thinking about a plan for unconventional measures if the recovery does not materialize,” said Martin van Vliet, senior euro-area economist at ING Bank NV in Amsterdam. “It may be too early for them to do that this month, but I’d expect Draghi to acknowledge that the economy is not improving and the chances of a surprise are bigger than they were.”
With Europe entering a second year of recession and fragmented financial markets preventing the ECB’s record-low borrowing costs from reaching the countries that need them most, Draghi may prefer to use so-called non-standard measures. He is particularly concerned about a lack of credit being extended to small and medium-sized companies in countries such as Italy and Spain, two of the officials said on condition of anonymity.
Rates on hold
The Frankfurt-based ECB will leave its benchmark rate at a record low of 0.75 percent Thursday, according to 54 of 56 economists in a Bloomberg News survey. Two predict a cut. The decision is due at 1:45 p.m. and Draghi holds a press conference 45 minutes later.
The Bank of England will hold its key rate at a record low of 0.5 percent and maintain bond purchases at 375 billion pounds ($568 billion), separate surveys of economists show. That decision is due at noon in London.
The Bank of Japan decided Thursday to increase monthly bond purchases to 7 trillion yen ($74 billion) in a bid to reach 2 percent inflation in two years. At the first meeting led by Governor Haruhiko Kuroda, it also temporarily suspended a cap on some bond holdings and dropped a limit on the maturities of debt it buys.
Economists from ABN Amro Bank NV to Nordea Bank AB say Draghi needs to give reassurance he still has policy options at his disposal as evidence mounts that the recovery is faltering.
The ECB’s measure of bank lending to the private sector fell for a 10th month in February, dropping 0.9 percent from a year earlier, and manufacturing activity, measured by a survey of purchasing managers, contracted more than economists forecast in March.
Case for action
“If you look at the world around you, with the economy weak, inflation falling to low levels, the disparities between countries and the credit mechanism not getting any better, you can’t conclude that no further action from the ECB is necessary,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. “The case for further action from the ECB remains very strong.”
Still, ECB officials haven’t provided clear guidance on what that further action might be. A rate reduction has been discussed since December, with Draghi saying last month that the “prevailing consensus” was against such a move.
That may be because lower ECB interest rates aren’t being fully passed on to the parts of the euro economy that really need them. A cut would also raise the issue of whether to take the deposit rate — the rate the ECB pays banks to park cash with it overnight — below zero.
The ECB may be more concerned with what Executive Board member Benoit Coeure on March 12 called the “disconnect” between official lending rates and those that businesses are actually charged.
More than four times as many small businesses in Spain were rejected for loans in the second half of last year than in Germany, or walked away from an offer because it was too expensive, research published by Barclays Plc shows.
While the ECB is studying ways to ease that fragmentation, such as the Bank of England’s Funding for Lending Scheme, Draghi said at last month’s press conference on March 7 that it isn’t “planning anything special.”
An asset-purchase plan targeted at small- and medium-sized business lending is far from straightforward, said Jan von Gerich, chief fixed-income analyst at Nordea Bank in Helsinki.
“There are a lot of expectations but they’re quite limited in what they can do,” he said. “It’s most likely for them to ease collateral requirements and make it easier to package SME loans. But it gets messy quickly and hawkish members are probably not comfortable with it.”
With excess liquidity in the banking sector halving in the past six months, lenders in some parts of the region might be in need of more central-bank funds. Longer-term refinancing operations, or LTROs, have been the ECB’s signature tool to ease tensions in financial markets and encourage lending, and policy makers may resort to this option again if they can’t find consensus on more complex measures, economists said.
Draghi is also likely to be questioned Thursday on the ECB’s role in Cyprus’s bailout. The ECB was party to and welcomed an initial plan to tax all deposits in Cypriot banks, which the nation’s parliament rejected.
While a revised agreement ditching a tax on deposits under 100,000 euros ($128,580) was negotiated over a week later under threat of the ECB cutting emergency funding to Cypriot banks, capital controls have been introduced for the first time in the euro region to prevent capital flight.
The episode damaged investor confidence across the currency bloc. The Stoxx Europe 600 Banks Index dropped 6.8 percent between March 15 and 27, the day before banks reopened in Cyprus.
The cost of insuring against default on European bank bonds surged 41 percent in that period, with the Markit iTraxx Europe Senior Financial Index of credit-default swaps on 25 lenders jumping 58 points to 201.
Allowing a flawed plan to go to the Cypriot parliament exacerbated the financial reaction to the bailout and harmed trust in Europe’s crisis-fighting abilities, said Ken Wattret, chief euro-area economist at BNP Paribas in London, who predicts a rate cut Thursday.
“The error originated in Cyprus, but the error from finance ministers and the ECB was to support it,” he said. “We saw an increase in stress in financial markets and a drop in economic sentiment. What we’re missing is a policy response.” [Bloomberg]