LDN - Business

ECB sticks to massive stimulus ahead of high-risk votes

[March 09, 2017] By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) - The European Central Bank pledged on Thursday to keep its aggressive stimulus policy at least until the end of the year, maintaining its support for the economy as anti-euro sentiment rises before elections in France and the Netherlands.

While expected, the decision showed the ECB's leadership was resisting calls from Germany to start winding down its 2.3 trillion euro ($2.43 trillion) bond-buying scheme, or at least signal its intention to do so, as growth and inflation rebound.

Instead, the Frankfurt-based central bank stuck to its plan of continuing the purchases -- which began two years ago -- until December. It pledged to keep interest rates at current, record-low levels until long after that, or even cut them if necessary.

"If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the program in terms of size and/or duration," the ECB said in a statement.

At a press conference due to start at 1330 GMT, ECB President Mario Draghi was expected to acknowledge that the outlook for the euro zone economy had improved but also point to political risks and a still fragile recovery.

The ECB is scheduled to cut the pace of its bond purchases by a quarter from next month but continue them at least until year-end, or longer if it thinks it has not yet reached its medium-term inflation target of almost 2 percent.

But nearly a decade after the 19-country currency bloc's economic woes began, it is looking in better shape.

Economic sentiment is at a six-year high, trade is rebounding, services and manufacturing output is rising, and unemployment is at its lowest since 2009.

Even inflation, the ECB's key objective, has rebounded, essentially hitting its target last month.

In this context, Germany's central bank governor Jens Weidmann and ECB director Yves Mersch have both made the case for ruling out further rate cuts.

And German Finance Minister Wolfgang Schaeuble said on Thursday he was in favor of a "timely start to the exit" from the ECB's loose monetary policy, echoing calls from the German banking association and the Ifo economic institute.

That leaves Draghi walking a tightrope, as improvements on the economic front are at risk of being derailed by hazards including the Dutch and French elections and global economic governance under new U.S. President Donald Trump.

Economists in a Reuters poll said the ECB's next move will be either a tweak of its guidance in the second half of this year or a gradual reduction in its asset-buying next year.

History may counsel caution. The ECB's most recent rate hikes, in 2007/8 and in 2011, both had to be rapidly reversed as economic conditions worsened.

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European Central Bank (ECB) headquarters in Frankfurt, Germany, July 29, 2016. REUTERS/Ralph Orlowski

"An important reason for not taking any hasty action is the ECB's own track record of jumping the gun," ING economist Carsten Brzeski said.

Still, the bank's deliberations may be heated, particularly because new inflation forecasts are likely to show an increase, partly due to a rebound in the price of oil.

At most the ECB may drop its reference to downside economic risks and let an ultra-cheap borrowing facility for banks expire as scheduled.

It may also debate but probably reject calls to give up a reference to lowering rates or buying more bonds if necessary.

FRANCE

Although Draghi may be reluctant to admit it, the French election is likely to be a particular concern. With far-right candidate Marine Le Pen wanting to take France out of the euro zone, markets are already bracing for a shock.

The cost of insuring French government debt against default has doubled since the start of the year <FRGV5YUSAC=MG> while the yield differential between five-year French and safe-haven German bonds rose to its highest since 2013 last month.

Investor nerves are also affecting debt of periphery countries such as Italy and Portugal even though the ECB's main indicator of stress in the financial system is trending downwards.

Next weekend's G20 meeting in the German town of Baden-Baden, the first since Trump took office, may further complicate the policy picture.

An early draft of the communique suggests the world's top finance ministers and central bankers may no longer explicitly reject protectionism or competitive currency devaluations. Under Trump, the United States has accused some trade partners, particularly Germany, of exploiting a weak currency.

Nevertheless, policymakers have so far suggested that the ECB is likely to begin discussing its next policy move only in June, with the first actual move perhaps not coming until after German elections in September.

"Our economists' baseline being that such a move is still six months away, with the possibility of an earlier announcement in June," Deutsche Bank strategist Jim Reid said.

(Editing by Catherine Evans)

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