ECB faces balancing act on rates as eurozone recovers
By Simon Morgan, AFPFRANKFURT -- The European Central Bank faces a delicate balancing act at its policy meeting this week as the nascent recovery in the crisis-stricken euro area remains extremely vulnerable to setbacks.
September 2, 2013, 12:07 am TWN
The ECB is not expected to unveil any policy changes at its regular monthly meeting on Thursday, but central bank chief Mario Draghi will have to tread extremely carefully if the positive effects of the most recent measures are not to evaporate, analysts argue.
The central bank's decision-making governing council “is facing a difficult situation,” said Commerzbank economist Michael Schubert.
Sentiment indicators in the single currency area are pointing upwards and hard data is starting to come in better than expected.
At the same time, “the effect of the (ECB's) forward guidance seem to be fizzling out a good two months after its introduction,” Schubert said.
UniCredit economist Marco Valli agreed.
“This mix of better growth data and higher money market future rates puts Draghi in a tricky situation where a careful balancing act is needed,” Valli said.
“On the one hand, recent growth news justifies a slightly more constructive tone” than at the bank's last meeting in August.
“On the other hand, Draghi will need to retain an easing bias consistent with forward guidance outlined in July in order to bring money market expectations more in line with the ECB's own assessment of economic fundamentals,” the expert argued.
Draghi in 'tricky situation'
Two months ago, Draghi ushered in what many ECB watchers saw as a revolution in communication policy by pledging to keep interest rates at their current historical lows — or even lower — for an extended period of time.
The ECB had previously cut its key refinancing rate to an all-time low of 0.50 percent in May.
Never before has the ECB issued such “forward guidance,” even if Draghi has faced tenacious questions ever since about exactly what an “extended period of time” actually means.
Financial markets have been spooked by speculation that the ECB could follow the United States Federal Reserve and start winding down its ultra-loose monetary policy, and that could strangle the still fragile shoots of recovery in the crisis-plagued euro area.
Already last month, Draghi “seemed to do his best to undo at least some of the good work,” Capital Economics economist Jonathan Loynes complained.
The Italian repeatedly dodged questions at last month's news conference on whether or not the governing council had discussed possible rate cuts at the meeting, before finally conceding that it had not.
And then Draghi “got himself into something of a twist in suggesting that the ECB might not repeat the commitment to keep rates on hold for an extended period every month, for fear of giving the impression that the guidance only applied for one month at a time,” Loynes said.
This elicited the obvious question of how markets and commentators would know when the pledge did come to an end, the expert noted.
ECB May Revise up Growth Forecasts
Valli at UniCredit suggested that the ECB's latest growth and inflation forecasts — also scheduled to be published on Thursday — would be “important cards in Draghi's hand.”
In June, the central bank said it was penciling in a contraction in gross domestic product (GDP) of 0.6 percent in 2013, followed by growth of 1.1 percent for 2014.