ECB inaction, holds interest rate at 0.25%

The ECB holds its benchmark interest rate at 0.25% after today’s meeting.

ECB (European Central Bank) president, Mario Draghi does not believe deflation is a threat.

Investors and economists will be disappointed at the ECB inaction, they had been calling on the central bank to reduce interest rates.

Eurozone deflation fears grew last week when the European Union’s statistical agency, Eurostat, announced that January’s inflation fell to 0.7% from December’s 0.8%, moving further away from the ECB’s target of 2%.

Draghi said:

“Incoming information confirms that the moderate recovery of the euro area economy is proceeding in line with our previous assessment. At the same time, underlying price pressures in the euro area remain weak and monetary and credit dynamics are subdued.”

“We are now experiencing a prolonged period of low inflation, which will be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on.”

“We have to dispense with this idea of deflation. The question is – is there deflation? The answer is no.”

ECB inaction today, but in March who knows?

Regarding the outlook for the medium term, the ECB says further analysis and data will become available at the beginning of March. Several newspapers today have quoted experts who believe the ECB may be forced to reduce interest rates in March if inflation continues to fall.

According to recent evidence, the ECB says its decision to maintain an accommodative stance on monetary policy for as long as it takes has been the right one. It is a policy that will help boost the gradual economic recovery of the Eurozone. “We firmly reiterate our forward guidance,” Draghi stressed.

The ECB expects its current interest rates to remain at their present or lower levels for a prolonged period. This expectation is based on a subdued outlook for inflation which likely will extend into the medium term “given the broad-based weakness of the economy and subdued monetary dynamics,” Draghi added.

The ECB says it is closely monitoring developments in the money markets after its recent volatility and is ready to consider all available instruments. Draghi said “Overall, we remain firmly determined to maintain the high degree of monetary accommodation and to take further decisive action if required.”

ECB’s economic analysis for the Eurozone

After two successive quarters of GDP (gross domestic product) growth, recent surveys and data suggest overall that the moderate economic rebound persisted into Q4 2013.

Looking ahead, the central bank says its previous assessment of economic growth has been confirmed – Eurozone output is forecast to continue recovering at a slow pace.

This year we should see some improvement in domestic demand, supported by the accommodative monetary policy stance, better financial conditions and the progress made in structural reforms and fiscal consolidation.

Real incomes are supported by reduced energy price inflation. Economic activity is predicted to benefit from stronger exports in the euro area.

At the same time, however, Eurozone unemployment is far too high, even though it is stabilizing. This will continue to weigh on the pace of the economic recovery.

Draghi added:

“The risks surrounding the economic outlook for the euro area continue to be on the downside. Developments in global money and financial market conditions and related uncertainties, notably in emerging market economies, may have the potential to negatively affect economic conditions.”

“Other downside risks include weaker than expected domestic demand and export growth and slow or insufficient implementation of structural reforms in euro area countries.”

The BBC quoted Holger Schmieding, chief economist at Berenberg Bank, who agrees with the ECB that the Eurozone is recovering. “Prices are stable. Leading economic indicators are close to trend. The European Commission’s Sentiment Index is at 100.9 which is actually a little bit above trend. So the recovery is happening. Draghi should have acted earlier, but belatedly, the recovery is on track.”

Many experts are convinced the ECB will have to cut rates in March as Eurozone inflation continues falling. In an interview with the Financial Times, Ken Wattret of BNP Paribas said regarding the ECB’s inaction “As we see it, the big picture has not changed. The bias to ease remains in place and the likelihood of more policy action in March is high”.

It appears that the ECB is hoping that growing activity in the corporate bond market may offset poor bank lending.

If the ECB does not push rates down the euro will probably not fall against the dollar. After Draghi’s speech the euro rose to just above $1.36, an increase of one cent.

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