ECB keeps rates on hold, sees recovery later in 2013

FRANKFURT Thu Jan 10, 2013 9:19pm IST

European Central Bank (ECB) President Mario Draghi addresses a news conference at the European parliament in Brussels December 17, 2012. REUTERS/Laurent Dubrule

European Central Bank (ECB) President Mario Draghi addresses a news conference at the European parliament in Brussels December 17, 2012.

Credit: Reuters/Laurent Dubrule

FRANKFURT (Reuters) - The euro zone economy will recover later in 2013 and there are already some signs of stabilization, the European Central Bank said on Thursday after it unanimously held interest rates at a record low.

The ECB left rates at 0.75 percent, following fledgling signs of life in the euro zone economy and with inflation still above target, and its president struck a more optimistic tone.

"The economic weakness in the euro area is expected to extend into 2013," Mario Draghi told a news conference. "Later in 2013, economic activity should gradually recover."

Last month, Draghi said there was "a wide discussion" on reducing rates, a comment that fed expectations a cut would soon follow.

On Thursday, the decision to keep policy on hold was unanimous, Draghi said, because some indicators had begun to stabilize, "albeit at low levels", while financial market confidence had improved significantly.

The euro climbed to a one-week high against the U.S. dollar, safe haven German Bund futures fell and European stocks rallied in response to the unanimous view that looser policy was not required.

"A rate cut this year seems more and more unlikely, unless the economic recovery disappoints in strength or timing," said Christian Schulz, economist at Berenberg Bank.

A Reuters poll published on Monday had pointed to the ECB keeping rates on hold, though the economists surveyed were split on the chances of a cut in the next few months.

Draghi remained cautious, saying the ECB was not thinking about an exit from its crisis policy measures.

"The risks surrounding the economic outlook ... remain on the downside," he said. "They are mainly related to slow implementation of structural reforms in the euro area, geopolitical issues and imbalances in major industrialized countries."

National government policies to reform and improve competitiveness remained of paramount importance, he said.

"POSITIVE CONTAGION"

Borrowing costs of euro zone countries at the sharp end of the bloc's debt crisis have tumbled sharply since Draghi pledged last year to do whatever it took to shore up the currency area, by buying government bonds in potentially unlimited amounts.

So far, that effect has endured without the ECB having to put its money where its mouth is.

"Bond yields and country CDS (bond insurance costs) are much lower, significantly lower. Stock markets have increased. Volatility is at a historical minimum," Draghi said, rattling off a list of factors that led the ECB to hold rates this month.

"We spoke a lot about contagion when things go poorly, but I believe there is a positive contagion when things go well, and I think that's also what is in play now," he added.

Inflation has eased more slowly than the ECB initially expected and as long as it misses the target -- it has been above 2 percent for more than 2 years -- a rate cut could be difficult to justify.

"Inflation rates are expected to decline further to below 2 percent this year," Draghi said.

Howard Archer, economist at Global Insight, said "the ECB appeared to close the door to an interest rate cut in the near term" but that a cut further out was still possible, predicting growth would be harder to foster than the central bank expects and unemployment would continue to rise.

"This is likely to put the ECB under increasing pressure to take interest rates lower," Archer said. "We suspect that there will be periodic flare ups in euro zone sovereign debt tensions as Spain and Italy continue to struggle markedly."

Another cut of the main refinancing rate would have raised the question of whether the ECB would also lower its deposit rate -- already at zero -- by the same amount, which would push it into negative territory, essentially charging a fee for banks to park money with it for the first time.

Even though Draghi has said the bank was "operationally ready" for such a step, it has grown increasingly wary of the idea, a source with knowledge of the ECB's thinking said.

Negative deposit rates could deal a hefty blow to money market funds, which have already seen cash outflows since the ECB cut the deposit rate to zero in July. The rate is a peg for short-dated money market rates and it is already almost impossible for funds to generate a return for their investors.

(Additional reporting by Sakari Suoninen and Paul Carrel. Writing by Mike Peacock. Editing by Jeremy Gaunt.)

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