Monday, 30 April 2018

Draghi hails "solid" growth as ECB keeps policy on hold

FRANKFURT (Reuters) - European Central Bank chief Mario Draghi played down concerns over softness in the euro zone economy on Thursday as the ECB kept policy on hold, bolstering expectations that it will halt bond purchases by year-end.

Draghi argued that the 19-country currency bloc’s economy remained strong but acknowledged evidence of a “pull-back” from exceptional growth readings seen around the turn of the year.

“Overall, however, growth is expected to remain solid and broad-based,” he told a news conference after ECB policymakers held their meeting.

Draghi said risks related to the threat of protectionism had become “more prominent” but stressed the bank was confident that it was on the right track towards gradually weaning the economy off an unprecedented period of stimulus.

“The bottom line is ... caution in reading these developments, caution tempered by an unchanged confidence in convergence of inflation to our inflation aim,” he said.

The ECB targets inflation of below but close to 2 percent.

The euro rose 0.3 percent to $1.2197 as Draghi spoke.

“The main takeaway is that nothing has changed in the ECB’s policy stance and they remain on course to taper later in the year,” said Marchel Alexandrovich, European financial economist at Jefferies.

With the euro zone economy expanding for 20 straight quarters and millions of new jobs created, the main debate among policymakers is about how quickly to withdraw stimulus and preserve ECB firepower for the next downturn.

In particular, they need to agree an end-date for the ECB’s 2.55 trillion-euro ($3.10 trillion) bond purchase program, which has cut borrowing costs and revived growth, even if it has failed to lift inflation back to the target.

With that scheme due to expire in September, the ECB will have to decide in June or July whether to extend purchases or wind them down. But with the risk of a global trade war still looming, it may not make a decision until absolutely necessary.

Business sentiment has already taken a hit, particularly in export-focused Germany, and a full-fledged trade war could quickly hurt growth — a risk already highlighted by policymakers at the ECB’s March meeting.

Draghi said a range of one-off factors including cold weather, labor strikes and the timing of the Easter holiday period had contributed to weakness seen in a number of read-outs across the euro zone in recent weeks.

With Thursday’s decision, the ECB’s bond purchases, aimed at stimulating growth and inflation through rock-bottom debt costs, will continue at 30 billion euros a month at least until the end of September, or beyond if needed to prop up inflation.

The deposit rate, currently the bank’s primary interest rate tool, will remain at -0.40 percent. The main refinancing rate will stay at 0.00 percent.

Economists polled by Reuters ahead of the meeting expected bond purchases to end this year after a short taper and to see the first rate increase in the second quarter of 2019. Some, however, have started to flag risks of a delay.

Their 2018 growth forecasts were unchanged at 2.3 percent, but most economists polled said the trade dispute between the United States and China would also damage the euro zone economy.

One worry is that protectionist rhetoric from the United States could push down the value of the dollar, an economic anomaly as the Federal Reserve is likely to raise interest rates several times this year, a natural support for its currency.

While U.S. 10-year yields hit 3 percent this month for the first time since 2014, German yields now around 0.61 percent — have barely edged up this year, suggesting that any ECB normalization will be extremely slow.

A stronger euro would cap inflation, a headache for the ECB. Inflation is already set to miss the target, the central bank’s sole policy objective, for years to come.

Euro zone inflation is so weak that even after the creation of 9 million jobs since early 2013, measures of underlying price growth that strip out energy and food are barely rising.

This suggests the euro zone’s economic downturn was more severe than earlier thought and makes the recovery even more protracted.

The impact of the euro’s strength has been limited so far, however. The currency is up 1.5 percent against the dollar this year and just 0.3 percent higher on a trade-weighted basis.

Even if the currency impact were to bite, the ECB has little scope to extend purchases much longer, suggesting it will take an extremely cautious approach to normalizing policy, even if it risks erring on the side of caution and moving too late.

($1 = 0.8214 euros)

Reporting by Balazs Koranyi

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