ECB Holds Rates as Ukraine Turmoil Menaces Recovery Hopes

August 7, 2014

Frankfurt (Aug 7)  The European Central Bank kept interest rates unchanged at record lows as the Ukraine crisis strengthened the headwinds facing the euro area’s recovery.

The 24-member Governing Council meeting in Frankfurt left the main refinancing rate at 0.15 percent, as predicted by all 57 economists in a Bloomberg News survey. The deposit rate and the marginal lending rate remained at minus 0.1 percent and 0.4 percent, respectively. ECB President Mario Draghi will hold a press conference at 2:30 p.m. to explain the decision.

With Italy relapsing into recession and signs of slower growth elsewhere, Draghi is likely to be questioned on how the 18-nation economy will cope with a conflict in Ukraine and sanctions against Russia that companies say is hurting trade. Draghi has said large-scale asset purchases are an option for dealing with a severe economic shock, leaving investors seeking clarification on what the trigger could be.

“We still think the bar for outright quantitative easing is quite high and the decision to buy European government bonds would require renewed recession or outright deflation,” said Philippe Gudin, chief European economist at Barclays Plc in Paris. “We do not expect the ECB to make significant announcements at today’s press conference.”


Troop Buildup

The Bank of England’s Monetary Policy Committee also kept its key interest rate unchanged today, at a record-low 0.5 percent, while its bond-purchase plan stayed at 375 billion pounds ($631 billion).

Russia has massed troops on its border with Ukraine and Russian President Vladimir Putin has responded to sanctions imposed on his country by banning an array of food imports from the U.S. and Europe.

The escalating crisis could yet derail the euro area’s recovery from its longest-ever recession. At Germany’s Siemens AG, Europe’s largest engineering company, Chief Executive Officer Joe Kaeser said geopolitical strife poses a “serious risk for Europe’s growth in the second half.” Belgium’s Anheuser-Busch InBev NV, the world’s biggest brewer, said beer sales in Ukraine plunged more than 20 percent in the second quarter.

“The euro-zone recovery is very fragile and the macro situation fluid,” said Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich. “Expect Draghi to elaborate on spillover risks from the Russia-Ukraine crisis.”

Low Inflation

Those risks aren’t making the ECB’s job any easier. While policy makers introduced a volley of measures in June, including a rate cut and a fresh liquidity program for banks, that stimulus will take time to feed through to the real economy.

Euro-area inflation is already running at less than a quarter of the ECB’s goal of just under 2 percent. Consumer prices rose 0.4 percent last month from a year earlier, the slowest pace in almost five years.

Italy, the currency bloc’s third-largest economy, unexpectedly slipped back into recession last quarter. Figures today showed industrial output in Germany, the biggest economy, was weaker than forecast in June. Data yesterday showed factory orders sliding by the most since 2011.

European stocks closed at their lowest level in almost four months yesterday and the euro at one point slid to its weakest against the dollar since November.

No Action

One question Draghi will likely face today is what he can do in response. The ECB president has said that an external shock that derails the baseline scenario of a gradual recovery in prices would require broad-based asset purchases. Getting policy makers to agree on what constitutes a shock may not be easy.

Governing Council member Ewald Nowotny said in an interview on July 10 that he doesn’t see any need for further action in the near future. Fellow council member Ardo Hansson told Bloomberg News on July 16 that there’s no immediate need for large-scale bond purchases. He also said a smaller program to buy asset-backed securities won’t be ready any time soon.

One reason not to jump in with additional steps now is that the euro area may be better able to absorb shocks than during the depths of the financial crisis. The collapse and government bailout of Banco Espirito Santo SA, once Portugal’s biggest lender by market value, hasn’t prevented euro-area bond yields from holding near record lows. Before the ECB meeting, the yield on German two-year bonds fell below zero for the first time since May 2013.

Shock Absorber

Manufacturing and services activity in the euro area measured by Markit Economics strengthened in July and the reading has been above 50, indicating expansion, for a year. A gauge of economic confidence for the region unexpectedly rose.

“It is undoubtedly true that downside risks going forward have been mounting recently due to geopolitical tensions,” said Andreas Rees, chief Germany economist at UniCredit MIB in Frankfurt. “Psychological burdens have increased recently. However, it is too early to call it a day.”

The next clue on the region’s inflation outlook will come on Aug. 14, when the ECB publishes its quarterly Survey of Professional Forecasters. In September, the ECB will probably revise its own forecasts lower, according to Marchel Alexandrovich, an economist at Jefferies International Ltd. in London. The ECB predicted in June that inflation will average 0.7 percent this year, with the rate accelerating to 1.4 percent in 2016.

“Putin’s behavior over the next few weeks is the key tail risk to watch,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The biggest risk to the recovery is the confidence shock which an open Russian invasion of Ukraine could cause across core Europe and beyond.”

Source: Bloomberg

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