April 2, 2014 / 11:15 PM / 5 years ago

ECB set to hold course in face of deflation fears

FRANKFURT (Reuters) - The European Central Bank looks set to keep interest rates steady and offer no new aid to the euro zone’s fragile recovery on Thursday despite a fall in inflation to its lowest in more than four years.

A structure showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt July 11, 2012. REUTERS/Alex Domanski

Policymakers have been willing in recent weeks to publicly broach cutting deposit rates below zero - effectively charging banks to hold cash with the ECB - or embarking on bond purchases as the United States, Japan and Britain have.

A straightforward cut in the ECB’s main refinancing rate to 0.1 percent from 0.25 percent - or more complex changes to existing market programmes - are other possibilities.

But there has been little sense that a majority of officials favours imminent use of any of those tools even though inflation has been below 1 percent for six months. Instead most may prefer to keep such policies on standby in case of an external economic shock.

“Policy rhetoric should lean in the direction of dovish. But it is unlikely that current economic and market conditions meet the watermark for ECB action,” said Lena Komileva, managing director of G+ Economics.

News on Monday that annual inflation in the 18-member euro zone fell to 0.5 percent appears insufficient to prompt action, despite concerns among some economists that the bloc risks slipping into a spiral of sinking prices and meagre growth.

Even after the data came out, 18 out of 22 money market traders polled by Reuters forecast no change in policy, echoing the finding of a larger Reuters poll of economists last week.

ECB Vice-President Vitor Constancio said the low rate of inflation could hamper growth but that there was no risk of deflation and that economic recovery would push prices up.

The ECB will announce its interest rate decision at 1145 GMT and ECB President Mario Draghi will explain any further policy decisions at a news conference at 1230 GMT at the central bank’s Frankfurt headquarters.

Draghi is likely to want to play up the ECB’s readiness to tackle downside risks to inflation, in order to stem a rise in the euro, which last month hit its highest level against the U.S. dollar since October 2011 and has a dampening effect on import prices the more it climbs.

“A combination of persistent top-line inflation weakness and persistent upward pressure on the euro will probably result in more dovish ECB rhetoric on the central bank’s willingness to fight downside risks to inflation,” Komileva said.

Pressure from abroad to act has mounted, most notably from the International Monetary Fund.

“More monetary easing, including through unconventional measures, is needed in the euro area,” IMF head Christine Lagarde said in a speech on Wednesday, outlining the Fund’s policy recommendations ahead of its spring meetings next week.


Last month, the ECB forecast it would take 2-1/2 years for inflation to rise to 1.7 percent, which even then would barely meet the target for annual price growth below but close to 2 percent.

That was insufficient to prompt a majority of policymakers to back more monetary stimulus, and to change their minds now would go against the central bank’s practice of not reacting to short-term moves in data.

That said, the ECB did cut its main interest rate in November after a surprise drop in inflation in October to 0.7 percent.

Other economic indicators are similar to last month’s, suggesting the ECB outlook that the euro zone will record economic growth of around 1.2 percent this year - the highest since 2011 - holds good.

Nonetheless, there may well be debate on the merits of future stimulus.

One option on the table is cutting the deposit rate that the central bank pays on the roughly 30 billion euros ($41 billion) deposited with it to below zero - effectively charging banks if they choose to hold money at the ECB rather than lending it out.

This has been tried out in recent years by the Danish central bank while Switzerland has threatened similar. Such a move could temper the euro but there is less evidence that it would succeed in increasing lending.

Buying government assets with newly created money - as favoured on a massive scale by the U.S. Federal Reserve, Bank of Japan and Bank of England - is a trickier prospect for the euro zone even though Bundesbank chief Jens Weidmann, normally a hardliner, has said it would be possible.

Only if deflation really looks like taking hold, will opposition to that be overcome.

($1 = 0.7249 Euros)

Editing by Mike Peacock

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