Saturday, January 14, 2012

Analysts: ECB likely to hold rates steady

(AP) ? The European Central Bank is likely to hold interest rates at its monthly meeting after two straight months of cuts, analysts believe, with some expecting Europe's debt crisis and a deteriorating economy to push the bank soon to take its key rate below the current 1 percent level.

President Mario Draghi's remarks at his post-decision news conference Thursday will be scrutinized for clues about how fast the bank thinks the European economy is slowing ? and what further steps it might deploy against the crisis caused by too much debt in the 17 countries that use the euro as their currency.

The bank lowered its key rate by a quarter point at the November and December meetings, the first chaired by Draghi after he replaced Jean-Claude Trichet, in a move that was seen as a signal of a more flexible approach to fighting the crisis. It also made unlimited amounts of cheap, three-year loans available to banks to steady the banking system.

Economists point to recent stabilizing economic indicators as reasons the 23-member governing council might wait before cutting again. Also, they note that Draghi indicated last month that some members of the council wanted to postpone the December rate cut.

Surprise decisions, however, cannot be ruled out, especially given recent big changes in top ECB leadership.

In addition to Draghi replacing Trichet in November, former Germany deputy finance minister Joerg Asmussen and former deputy director general of the French Treasury Benoit Coeure took seats on the six-member executive board that runs the bank day to day. Additionally, the job of supervising the ECB's staff economists last week was assigned to Belgian executive board member Peter Praet ? the first time a non-German has held the post since the bank was founded in 1998.

Praet's appointment is significant because German predecessors Otmar Issing and Juergen Stark represented their country's conservative economics tradition stressing low inflation ? and were seen as strong voices to keep rates higher.

Now economists are trying to gauge whether the bank will make more cuts in the coming months. A number think the bank could take its refinancing rate as low as 0.5 percent by the end of the first quarter. That would put it in territory now occupied by the U.S. Federal Reserve, whose key rate is 0-0.15 percent, and the Bank of England, which is also to set its rates Thursday, where the benchmark rate is 0.5 percent.

Much depends on how the bank sees the economy. Many economists predict that fourth-quarter figures will show the eurozone shrank in the last three months of the year when they are published next month. Rate cuts can spur growth by making borrowing cheaper for businesses and consumers.

Analysts at Bank of America-Merrill Lynch think sagging growth will lead the ECB to cut quickly by a quarter point both Thursday and at the February meeting to "take preventive action against economic deterioration."

Not all agree. Marco Valli, chief eurozone economist at UniCredit, sees the refinancing rate "steady at 1 percent throughout the year." That could change, Valli cautioned, if growth slips more sharply than expected or if market turmoil from the debt crisis increases.

The bank is not expected to change its position on one of its key anti-crisis measures ? its program to buy government bonds. That helps keep down the elevated borrowing costs for indebted governments that have been a key force in worsening the debt crisis. The purchases drive down interest yields on bonds in the secondary market. That means the governments face lower borrowing costs when they sell bonds to pay off older bonds that are maturing.

Fears of a default drove borrowing costs so high for Greece, Ireland and Portugal that they could no longer afford to borrow. They needed bailout loans from other eurozone governments to avoid defaulting on their bonds.

Yet the ECB has stayed with its firm line that the program is limited in size and duration, and that it remains the job of governments to reduce their budget deficits and show the investors that buy their bonds that they are creditworthy ? and should be able to continue borrowing at affordable rates. Italy's new Prime Minister, Mario Monti, has made new cuts and promised steps to improve growth. But the interest yield on the country's 10-year bonds remained at an elevated 7.13 percent ? the kind of levels that led Greece, Ireland and Portugal to give up and take bailouts.

The program ? which has bought some euro211 billion ($270 billion) in bonds ? has been a key backstop in the absence of more robust eurozone bailout funds. The current funds have some euro500 billion ($640 billion) in financing available. But some of that is already committed to Greece, Ireland and Portugal, and Italy ? the recent focus of the crisis ? is too big for the fund to bail out for more than a short time. Eurozone officials are also seeking another euro150 billion ($192 billion) in funding from governments for the International Monetary Fund, which could then use it to backstop indebted governments.

Some analysts think a worsening of the crisis will eventually force the ECB to use its power to create new money and buy much larger amounts of government bonds. That, the reasoning goes, could convince markets that borrowing rates will stay down and not result in government defaults.

Jennifer McKeown, senior European economist at Capital Economics, said a deteriorating economy could push the ECB to engage in what is called quantitative easing. That means buying financial assets across the eurozone as a way of pushing newly created money into the economy and promoting growth. It is an additional tool that central banks can use when interest rates are about as low as they can go. Both the U.S. Federal Reserve and the Bank of England engaged in it but there are disputes over whether the ECB's anti-inflation mandate permits it; Lorenzo Bini Smaghi, a former top ECB official, indicated in an interview last month before he left the bank that quantitative easing would be possible to combat deflation, or a crippling fall in prices. That would be in line with the ECB's mandate from the EU treaty to pursue price stability as its first goal.

"They might not go below 1 percent in this cycle, in fact they might choose to do more unconventional measures, even quantitative easing, rather than cutting the interest rate below 1 percent," McKeown said.

While further rate cuts are possible, "it's not clear how much difference a reduction from 1 percent to 0.75 percent or even 0.5 percent would make," she said. "If the economy really needs more support and the ECB believes that is the case, I think it would need to move into quantitative easing to really help matters."

Associated Press

Source: http://hosted2.ap.org/APDEFAULT/f70471f764144b2fab526d39972d37b3/Article_2012-01-10-EU-Europe-Interest-Rates/id-358af9ec08c94c11954daff37c7b459d

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