Monday 23 April 2018

Eurozone interest rates could stay frozen well into 2019


When will the European Central Bank join the U.S. Federal Reserve and start raising interest rates? This much is clear: It won’t be soon.

Weaker signals from the economy and worries about a possible trade war between the United State and China have left the top monetary authority for the 19 countries that use the euro in no hurry to start withdrawing its monetary stimulus.

And that means the central bank’s short-term interest rate benchmark will almost certainly stay at zero well into next year, ensuring low borrowing costs for businesses but miserly returns for savers.

Analysts think ECB President Mario Draghi will try to say as little as possible Thursday about when the bank might phase out its 30 billion euros ($37 billion) per month in bond purchases, currently slated to run at least through September. The ECB would only start considering raising rates once the bond-buying is over.

The bank’s 25-member rate-setting council meets at the bank’s skyscraper headquarters in Frankfurt, Germany, to set monetary policy for the 19 countries that are members of the euro currency union. No changes in stimulus settings or interest rates are expected. But Draghi’s post-meeting news conference will be closely parsed for clues about the end of the bank’s monthly bond purchases — clues that Draghi may not especially care to give right now. The purchases are set to run at least through September but the bank has otherwise left the end date open.

Several analysts think the bank will decide only in June or July whether to extend the purchases.

“Our best guess is that Mr Draghi will strike a balance between expressing optimism about the economy, and concern about recent bad news,” said Jack Allen, European economist at Capital Economics.

The bank has struggled to raise inflation from the current 1.3 percent annually toward its goal of just under 2 percent. The bond purchases aim to do that by increasing the amount of money in the economy.

Extending the bond-purchase stimulus for another few months might not have a huge impact by itself. Its key influence would be on expectations for when the bank might follow the U.S. Federal Reserve and finally start raising rates after years of unprecedented monetary stimulus. That is because the ECB has said it will only raise rates “well after” the end of the purchases. So a purchase extension, even with a reduced amount of, say, 15 billion euros a month has the effect of pushing the first rate increases even farther into the future.

If the purchases cease at the end of this year, that could push a first rate rise from the current record low of zero into mid- or even late 2019.

That means continued monetary stimulus the bank considers critical for the economy to keep growing. But more stimulus for longer can also have side effects, such as the risk of inflating some markets, like housing or stocks, and propping up inefficient companies that couldn’t survive without ultra-cheap borrowing.

Behind the bank’s caution: slightly weaker data on industrial production, retail sales and construction suggest the eurozone is going through a period of slightly lower economic growth in the first months of 2018, after a robust increase of 2.5 percent in 2017, the highest in 10 years. Also, Draghi has said that escalating trade tensions could hit business confidence, though the initial impact of steel and aluminum tariffs imposed by U.S. President Donald Trump would be small.

An eventual stimulus exit will have wide ranging impacts on markets, business and consumers. The bank must move cautiously to avoid panicking stock markets that have risen thanks to extensive central bank stimulus after the 2008-9 global financial crisis and Great Recession.

Rising short term rates would mean more returns for savers, while higher long-term rates would mean greater debt service costs for governments and home buyers. Higher rates could also send bond prices lower; but higher returns on bonds and certificates of deposit over the long term would make them more attractive compared with riskier investments like stocks.



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