ECB to hold policy as economy improves

Tentative signs the euro zone’s recession may be coming to an end will give the European Central Bank room to hold off further stimulus when it meets on Thursday to discuss interest rates.

The latest euro zone purchasing managers’ (PMI) survey took some pressure off the ECB as it swung into growth territory. Economic morale hit a 15-month high in July, adding to signs the bloc is emerging from its longest recession since records began in 1995.

Unlike the U.S. Federal Reserve, which is likely to have a lively debate at its policy meeting on Tuesday and Wednesday on how best to prepare financial markets for a reduction of its bond purchases, the ECB is far away from such exit debates.

Instead, it is seen to stand by last month’s forward guidance, expecting rates to stay at 0.5 percent or lower for an “extended period”, though it may be pressed for clarification after cacophony of comments by policymakers blurred the message.

In a Reuters poll of 70 economists, conducted before the PMI survey came out last week, all but one expected the ECB to hold policy rates steady at Thursday’s meeting.

“I suspect that ECB President Mario Draghi wants to steer a steady course at this month’s press conference,” said Mark Wall, economist at Deutsche Bank in London. “The ECB is likely to prove patient in how it interprets the gap between an improvement in PMIs and still weak money supply and bank lending data. The ECB can afford to wait and see.”

Unemployment is at a record high and inflation has slipped below the ECB’s target of below but close to two percent. It is expected to fall further as euro zone countries cut spending and implement reforms to become more competitive.

With the euro zone economy still in a fragile state, the ECB is far from pulling the plug on its ultra-loose monetary policy.

To assure investors unnerved after the Fed announced its plans to slow stimulus, the ECB turned to forward guidance in July. Markets calmed, although not entirely.

The ECB will remain on alert. If a recovery fails to materialise and money market rates keep rising, a rate cut could become an option again. The bank discussed a cut extensively at its July meeting, though in the end opted against it.

Morgan Stanley economists said the September policy meeting would be more suited to “pull the trigger on rates again”, pointing to a fresh round of staff projections and better visibility on how the second half of the year is progressing.

The International Monetary Fund already believes further action is needed to support the battered euro zone economy, calling for further cuts to rates, including the deposit rate that is now at zero, and potentially another long-term refinancing operation (LTRO) or direct asset purchases. (Reuters)