Abu Dhabi, UAETuesday 19 November 2019

ECB chief keeps rates unchanged

Draghi not keen on causing market turbulance

Mario Draghi, the ECB president. The ECB has kept rates unchanged. Johannes Eisele / AFP
Mario Draghi, the ECB president. The ECB has kept rates unchanged. Johannes Eisele / AFP

The European Central Bank has left its interest rate benchmarks and policy statement unchanged, underlining its reluctance to roil markets with premature signals about an exit from its stimulus efforts.

The decision was announced Thursday after a regular meeting of the bank's 25-member policy council at its headquarters in Frankfurt, Germany.

The monetary authority for the 19 countries that use the euro currency said in its policy statement that it will keep injecting €60 billion (Dh253.09bn) in newly printed money into the economy every month at least through the end of the year, and longer if necessary.

Investors were watching closely to see if the bank would drop language that the purchases could be increased or extended. That would have been a verbal step toward the exit. But the wording was unchanged.

Markets are now waiting for the post-decision news conference held by bank president Mario Draghi for clues about the bank's plans.

ECB officials have been cautious about signalling any exit from the bond purchase program. That is even though most analysts think the bank will have to taper off the purchases next year because it will start running out of eligible bonds to buy.

Markets reacted sharply to remarks by Mr Draghi in a speech on June 27 where he spoke about gradual reductions in stimulus as the economy grows stronger. The euro went higher and so did interest yields on longer-term bonds, developments that could prematurely blunt the stimulus effect.

The end of the stimulus will eventually have wide-ranging effects on investors, governments and ordinary people. Long-term interest rates should rise. That would mean governments would pay more for interest costs and have less left over for roads, schools and salaries. In particular, an end to the bond purchases could mean more pressure on highly indebted euro-zone members such as Italy, which are currently paying very little to refinance their large debt piles. A growing economy, however, means that an immediate return to the debt crisis of 2009-2012 is considered unlikely.

On the consumer side, home buyers would get less house for a given mortgage amount due to a higher share of interest costs. Savers, on the other hand, might see more return on conservative holdings such as bank deposits and CDs and life insurance policies. Higher rates would make riskier investments such as stocks.

Despite its current caution, the ECB faces the prospect of having to start phasing out stimulus next year even though it shows little sign of reaching its goal: a higher rate of inflation. The annual inflation rate in June was 1.3 per cent, still far from the bank's goal of just under 2 per cent - and that despite the huge stimulus running since March, 2015. The bank must hope that the economic recovery eventually pushes up inflation as new jobs are created and companies pay workers more. The economy has picked up some pace this year and the European Commission predicts the euro zone will grow 1.7 per cent this year and 1.8 per cent next year.

Through the bond purchases, the ECB effectively creates new money in the economy. The aim is for that money to find its way to companies and consumers in the form of credit. Increasing the supply of money in the economy can in theory raise inflation. The bank considers its inflation goal to be the level most consistent with a healthy economy. Low inflation sounds good to consumers but can make it harder for indebted companies and countries to pay down their burdens. It also makes it harder for weaker members of the euro zone to reduce their business costs relative to other countries and sell more goods through trade.

The ECB has made it clear that it will hold its benchmark interest rate at zero well after the purchases end. That means no rate increase is foreseen by analysts until 2019.

Updated: July 20, 2017 04:30 PM