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ECB holds rates, markets watch for signs of later cut

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(Globalpost/GlobalPost)

The European Central Bank kept interest rates on hold on Thursday, waiting to see if a recession-hit economy perks up and whether an aggressive policy move by the Bank of Japan helps the euro zone.

Investors' attention will now shift to ECB President Mario Draghi's 8.30 a.m. EDT news conference for any signals about the bank's preparedness to lower borrowing costs for the 17-country euro zone in the coming months.

As the world recovers from the financial crisis, the ECB has lent less support to the economy than its peers in Japan, the United States or Britain, which have launched massive asset purchase programs with new money and cut rates closer to zero. The Bank of Japan went a step further on Thursday. Its new governor, Haruhiko Kuroda, shocked markets with a radical overhaul of its policymaking, adopting a new balance sheet target and pledging to double its government bond holdings in two years as it seeks to end nearly two decades of deflation.

The ECB held its main rate at a record low of 0.75 percent - still the highest level among the world's major central banks. "This is as expected," said Citi economist Juergen Michels. "In the press conference, we expect them to take a more dovish tone, taking into account the recent weak sentiment data, the fall in inflation ... and opening the door for a rate cut in the next month or two."

A survey released earlier on Thursday showed the euro zone's economic decline dragged on unabated in March, marked by a huge drop in French business activity that outstripped even the downturns in Spain and Italy. Japan is intent on pushing inflation higher, lifting the country out of decades of deflation and minimal growth.

The ECB, which focuses on delivering inflation just below 2 percent, is unlikely to pursue a similar path. Euro zone inflation eased to 1.7 percent in March. "Apart perhaps from loosening some of the collateral rules again, we don't expect that the ECB is yet ready to launch into any programs in terms of purchases of assets," said Citi economist Guillaume Menuet. The scope of the Japanese changes drove the yen lower and knocked the 10-year bond yield to its lowest in a decade. Earlier this week, ECB Executive Board member Benoit Coeure warned against countries directly pursuing competitive devaluations, especially if other central banks had limited room for maneuver.

Recovery stalls

After early signs of stabilization in the euro zone economy at the start of the year, March marked a set back as Cyprus narrowly escaped a financial meltdown by securing a last-minute bailout and Italy struggled to end a post-election deadlock.

Euro zone economic sentiment fell after four months of gains, surveys showed manufacturing across the bloc fell deeper into decline and inflation eased to 1.7 percent, departing further from the ECB's target of below, but close to 2 percent. One month's readings will not be enough to change the ECB's policy stance, but any indication of heightened concern about growth prospects or the inflation outlook will not go unnoticed at Draghi's news conference. Draghi will also likely be asked by reporters whether the Cyprus rescue deal that for the first time penalized large bank depositors will serve as a model for future bank bailouts, something some ECB policymakers have denied.

The ECB's main worry is that its low rates are not reaching households and firms in the euro zone periphery, mainly because banks' funding costs in crisis stricken countries are higher than those in the core countries, pushing up loan costs. This affects small and medium-sized enterprises (SMEs) in particular as they have few alternatives to bank funding. Draghi said after the March policy meeting that the ECB was studying ways to address the issue, but that they were not planning "anything special". Since then, several policymakers have said a number of options were being looked at.

http://www.globalpost.com/dispatch/news/asianet/130406/ecb-holds-rates-markets-watch-signs-later-cut