ECB likely to hold interest rates at record low

The European Central Bank, eyeing tentative signs of euro zone economic recovery, is expected to eschew any major decisions on Thursday and keep its easy-money policy in place.

It will contrast with plans by the U.S. Federal Reserve to begin to withdraw its economy-boosting stimulus.

In Europe, such a step is far off and ECB policymakers have gone out of their way to assure investors that they will not follow the Fed any time soon, seeking to calm markets.

But like the United States, where recovery is far more advanced, there are signs of growth improvement. So rather than pump more money into the economy, the ECB is likely to hold interest rates at a record low of 0.5 percent.

They will stay there until at least the end of next year, a Reuters poll of economists suggested.

“We don’t expect any ground-breaking policy response (at the ECB meeting on Thursday),” Nomura economist Nick Matthews said. “At the moment the incoming data is going to be viewed as in line with the base line scenario (of mild recovery) and that will continue to give the ECB some breathing space.”

Euro zone annual inflation edged closer to the ECB’s target for a second month in a row, reaching to 1.6 percent in June from 1.2 percent in April while European manufacturing activity showed signs of stabilisation, but unemployment remains high.

“Thursday is Independence Day in the United States and this is going to be the main message from the ECB in terms of declaring it is in an independent stance, emphasising that the exit is distant and reinforcing the message to markets that the ECB is not the Fed,” Matthews said.

Investors will nonetheless listen carefully to ECB President Mario Draghi at the news conference after the meeting for any clues as to whether the ECB is more open to deploying its policy options than a month ago, when he said they were on the shelf.

One of the tools the ECB is looking at is forward guidance – a way for central banks to add more stimulus and reduce volatility by guiding markets where interest rates will be in future, especially once rates have reached their lowest limit.

The Fed does it and the Bank of England may soon start.

In his strongest form of guidance so far, Draghi said last week an exit from the ECB’s ultra-loose policy stance “is still distant since inflation is low and unemployment high”.

Over the weekend, policymaker Benoit Coeure hinted the ECB could go further, saying it was looking carefully at the Fed’s experience of giving future guidance, but adding that it was too early to say if the ECB was going to take a bigger step in that direction.

The Fed, frustrated by a fitful U.S. recovery, has promised to keep its main interest rate near zero at least until the unemployment rate falls to 6.5 percent and as long as inflation stays below 2.5 percent. It has now also laid out an exit plan.

Mark Carney, who will host his first policy meeting as Bank of England governor this week, is also expected to provide a plan for long-term policy commitments in August, having introduced forward guidance at the Bank of Canada in 2009.

This could strengthen the case for the ECB to follow suit, said Richard Barwell, senior European economist at RBS.

“One reason why the resistance to doing forward guidance at the ECB might be crumbling is that everyone else is doing it, to avoid being the last man standing not doing guidance – especially if Carney does it in August,” Barwell said.

But tying the ECB’s interest-rate moves to a timeframe or data is difficult considering that the 17 euro zone countries are going through profound structural changes and the ECB has a single mandate to preserve price stability.

The ECB can still cut interest rates a little bit further if pressure on short-term money market rates gets too strong with excess liquidity drying up as banks repay crisis money.

Once rates have hit rock-bottom, some economist have suggested the ECB could launch a long-term refinancing operation (LTRO) of up to five years with a fixed, rather than indexed, rate to provide certainty and reduce volatility.

But critics said it was questionable whether investors would really believe that the ECB would not raise rates while the fixed-rate tender was out should conditions change dramatically.

“At this stage all the ECB has to do is signal that they have something really powerful in their back pocket if inflation starts drifting too far south. For me, such an (extra large) LTRO is more powerful than anything else,” Barwell at RBS said.

“It’s just talking, not doing for now,” he said. Source: Reuters