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Eurozone rates unchanged despite deflation fear

February 6, 2014

FRANKFURT, Germany (AP) — The European Central Bank is sizing up the problems facing the 18-country eurozone before it decides whether to cut interest rates to support the anemic recovery, its president said Thursday.

Weak growth and an unexpected drop in inflation have raised concerns that the eurozone might slide into deflation, a sustained drop in prices that can cripple the economy. The eurozone is among the world’s biggest economic blocs, and a slide into deflation would crimp global growth.

But the ECB’s governing council left its interest rate benchmark unchanged at a record low of 0.25 percent at its meeting Thursday. Some analysts had thought it might cut the rate to 0.1 percent.

In his news conference, Mario Draghi signaled the ECB was in a wait-and-see mode. He repeated the bank’s promise to keep rates low “for an extended period” until the economy picks up more speed. And he said that if the economic data worsened, the bank would be ready to act to support a recovery he described as “fragile.”

Draghi said the picture of the economy was “complex” and that the ECB was trying to discern whether some poor indicators in recent days are signs of longer-term trouble.

It is not clear, for example, whether a slowdown in growth in emerging markets, where financial markets have been highly volatile in recent weeks, will be enough to cause serious damage to trade partners like the eurozone. Also, the recent drop in inflation — to 0.7 percent, far short of the ECB’s target of just below 2 percent — may eventually pick up.

The ECB has “to look through this volatility and see whether it is a temporary phenomenon,” he said.

The bank, he said, remained “willing and ready to act” with any of its available measures if it sees inflation falling further, or if credit conditions tighten. A small spike in overnight borrowing costs last month raised concerns among economists, but proved to be transitory.

Officials at the ECB are working on different stimulus steps “so when the time comes to activate we are ready to go.”

Draghi said he didn’t expect deflation to take hold in Europe because there was no downward price spiral feeding on itself.

Analyst Christian Schulz at Berenberg Bank said that despite Draghi’s extensive explanation of why the bank didn’t act, “the door to further steps remains wide open, as headline inflation stays weak.” Schulz said that next month’s meeting “could be crucial” because the bank will have new inflation forecasts that could provide a basis for action.

The euro rose sharply on the ECB’s decision to keep rates on hold, jumping over half a cent to $1.3604 by late afternoon Europe time. Higher rates can send a currency up because they offer relatively higher yields for investors.

The benchmark refinancing rate is what the ECB charges banks for loans, and through them influences the cost of credit for everybody else. Cutting the rate in theory makes it easier for people to buy new homes and for businesses to borrow and expand production. However the ECB has cut almost as far as it can.

Other actions on top of that could include offering cheap loans to banks as a way to encourage lending and push down the cost of short-term credit in the market.

It’s also theoretically possible for the ECB to buy bonds to pump newly created money into the economy, as the U.S. Federal Reserve, Bank of England and Bank of Japan have done. That step seems less likely. ECB officials have alluded to the complexity of bond purchases given 18 different governments that issue debt.

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