Draghi’s rate cut puts ECB into holding pattern until next year

Mario Draghi won’t follow his unexpected interest-rate cut with new liquidity injections into the financial system next month, economists say.

While a majority in a Bloomberg survey say the European Central Bank’s most probable next move is a measure such as long-term loans, 77 percent of those see it happening in the first or second quarter of 2014. Just 9 percent see Draghi taking action in December.

The ECB’s surprise policy move this month has taken the benchmark rate to a record low of 0.25 percent. That’s sparked speculation among economists and investors how far policy makers are prepared to go if inflation, already less than half of the ECB’s target, slows further, or the economic recovery weakens.

“The ECB wants to understand the effect the rate cut has had on liquidity, on credit growth and on monetary aggregates,” said Matteo Cominetta, European economist at HSBC Holdings Plc in London. “If the effects are not significant, they will go for a new LTRO. I think they will have to act again.”

ECB officials are drawing up plans to keep money flowing to banks to head off a liquidity squeeze when the first round of emergency long-term loans comes due in early 2015. A technical committee asked by Draghi to consider solutions met last month, according to two euro-region central bank officials familiar with the matter.

New liquidity measures could comprise longer-term refinancing operations with fixed or floating rates, different maturities or rules on how banks must use the cash. Other possible measures include changes to reserve or collateral requirements or the suspension of liquidity-absorbing operations.

The ECB already extended its policy to provide banks with as much liquidity as they need until mid-2015. Draghi said on Nov. 7 that officials are “ready to consider all available instruments” to ensure money-market conditions don’t hamper the transmission of the bank’s expansionary policy to companies and households.

In the Bloomberg survey of 37 economists, 60 percent forecast that the ECB’s next move will be a liquidity injection. A further 8 percent see a liquidity measure coupled with a rate cut. Eight percent also predict a cut in the main refinancing rate alone, with the same percentage seeing a negative deposit rate. Two economists said the ECB would implement quantitative easing.

“For the ECB’s monetary policy to have any traction it has to go to the next level,” said Steven Barrow, an economist at Standard Bank Plc in London, who did not participate in the survey. “The bank has shown it can be innovative with monetary policy. It has helped to save banks with its LTROs and save sovereign bonds with its OMT. The next challenge is to save the euro zone from the scourge of deflation.”

ECB Chief Economist Peter Praet told the Wall Street Journal that policy makers are ready to consider all options to ensure price stability. While he said that additional stimulus isn’t needed at the moment, asset purchases could be deployed.

Inflation in the 17-nation euro area slowed to 0.7 percent in October, the lowest level in four years. The region’s economy came close to a halt in the third quarter as German growth slowed, France’s economy unexpectedly shrank and Italy extended its record recession.

The median forecast in the Bloomberg survey is for the economy to expand 0.2 percent this quarter and 0.3 percent in the first three months of 2014. After an expected contraction of 0.4 percent in 2013, the survey projects growth of 1 percent next year. In a separate survey last week, economists forecast U.S. growth of 2.6 percent in 2014.

On the outlook for the ECB’s main rate, the median forecast is for it to remain unchanged until at least the second quarter of 2015.

At the Nov. 7 ECB meeting, Bundesbank President Jens Weidmann, Germany’s representative on the Executive Board, Joerg Asmussen, and members from countries traditionally aligned with the country’s conservative policy stance were against the rate cut, two central bank officials said. The opposing minority comprised as much as a quarter of the Governing Council.

Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, said the ECB will come under “enormous pressure” to take its deposit rate below zero and “pump more cheap money” into financial markets if economic conditions in the currency bloc deteriorate significantly.

“But we are not there yet by a long shot,” he said. “If there was already significant opposition on the ECB board by the German-led group to a belated and rather ineffective 25 basis- points cut, you can imagine what the opposition to another cut rate, another LTRO or outright asset purchases might be.”

Policy makers left the deposit rate, the rate for commercial lenders who park excess cash at the central bank, at zero after they signaled that the effects of taking it into negative territory can’t be adequately predicted.

On the one hand, the move could encourage banks to lend money to companies and households instead of keeping it at the ECB. However, it could also hamper their profitability as they may not be able follow the ECB into negative terrain. As a result, the spread between the rate banks charge for loans and the amount they pay depositors gets compressed.

Yet officials aren’t ready to exclude the option.

“Euro-zone economic prospects remain weak and inflationary pressures low; consequently, the ECB will remain under significant pressure to ease monetary policy again,” said Duncan De Vries, an economist at NIBC Bank NV in The Hague. “Although the ECB can still cut policy rates somewhat further and provide additional liquidity to the markets, we should be prepared for everything going forward.”


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