SENSEX NIFTY
Sep 05, 2013, 06.46 PM IST | Source: Reuters

ECB holds rates, Draghi's guidance under market microscope

Abandoning its tradition of never pre-committing on future moves, the ECB said in July it would keep its rates at current or lower levels for an "extended period" - its first use of forward guidance.

ECB holds rates, Draghi's guidance under market microscope

The European Central Bank left interest rates unchanged on Thursday, and markets turned their attention to ECB chief Mario Draghi's news conference for any signs a euro zone recovery will affect the bank's policy stance.

Abandoning its tradition of never pre-committing on future moves, the ECB said in July it would keep its rates at current or lower levels for an "extended period" - its first use of forward guidance.

However, the move has failed to bring down market rates - a task made all the harder for Draghi by the fledgling euro zone recovery and a looming Federal Reserve meeting later this month, at which it could begin to unwind US stimulus.

Also read: EMs to fight alone against further forex falls: Poll  

"This is as expected," Berenberg bank economist Christian Schulz said of the ECB's decision to leave its main refinancing rate on hold at a record low of 0.5 percent.

"All eyes will be on the press conference," he added. "It's all about how confident the ECB is this recovery will last, and what that may mean for their guidance. The more this recovery gains speed, the less likely it is they will cut rates."

Draghi begins his news conference at 1230 GMT.

Recent economic data has come in relatively strong, largely validating the ECB's main scenario of a gradual recovery taking hold in the second half of this year and gathering pace in 2014.

However, a rise in forward market interest rates has already caused consternation among the bank's policymakers. Draghi cautioned last month that market expectations of an interest rate rise are "unwarranted".

That verbal intervention did little good, and market rates have continued to rise despite the warning and the ECB's July assurance - repeated in August - that it would keep its policy rates at current or lower levels for an extended period of time.

Much of the market rate pressure is linked to the global impact of the Federal Reserve heading towards cutting back its stimulus programme - a dominant factor in global finance.

But a cacophony of policymaker views on what the ECB's first stab at forward guidance actually means has diluted its impact and analysts say the central bank's main challenge this month is to make it more credible instead of lowering interest rates.

"We are expecting ECB President Draghi to strike a dovish tone to reinforce the Governing Council's forward guidance," said Nomura economist Nick Matthews.

All 60 economists in a Reuters poll had expected the ECB to keep its main interest rate at 0.5 percent.

Markets want to hear whether the Governing Council discussed a rate cut, which the policymakers appeared not to last month. This would help strengthen the bank's easing bias on policy.

"Last time, one of the mistakes Draghi made was saying they didn't even talk about a rate cut," ABN Amro economist Nick Kounis said.

While waiting before any action, Draghi could stress the ECB still has other tools, including another ultra-long-term liquidity measure to tide banks over a potentially rocky period of asset-quality review and stress tests over the next year.

SOUTHERN COMFORT

Euro zone businesses had their best month in over two years in August as orders increased for the first time since mid-2011, a survey showed on Wednesday, suggesting the region's economy will grow slightly this quarter after 0.3 percent growth in the second.

The Governing Council will also welcome the fact that interest rates banks charge companies in debt-ridden southern Europe are falling more than in core euro zone nations, even as the gap between them remains wide.

Widely varying borrowing costs across the 17-country bloc have developed into a major headache for the central bank, which charges banks a flat 0.5 percent interest rate for loans.

In July, the interest small businesses have to pay fell most in the debt-ridden countries and the central bank's measure of country-by-country variation fell to its lowest level since August last year.

However, the amount of money euro zone firms borrowed fell at its fastest pace since the inception of the euro in July.

Weak lending, combined with rising market rates, will keep the ECB from putting a much happier face on the growth outlook in its latest set of staff economic projections to be published on Thursday, and Draghi is expected to emphasise that the growth outlook is still subject to downward risks.

"Draghi will be very cautious on the growth outlook, repeat what they have said before, that they are on track with a very gradual recovery," Societe Generale economist Anatoli Annenkov said.

ADS BY GOOGLE

video of the day

All portents good; optimistic for next few Diwali's: Damani

Explore Moneycontrol

Copyright © e-Eighteen.com Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of moneycontrol.com is prohibited.