ECB determined to prevent too low inflation

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ECBJan92013

Reuters.

European Central Bank (ECB) President Mario Draghi speaks during the monthly ECB news conference in Frankfurt January 9, 2014. The European Central Bank said on Thursday it was determined to use all available tools to prevent inflation falling too low, but left interest rates unchanged despite price rises slowing further into a "danger zone" below 1 percent.

Frankfurt - The European Central Bank said on Thursday it was determined to use all available tools to prevent inflation falling too low, but left interest rates unchanged despite price rises slowing further into a “danger zone” below 1 percent.

ECB President Mario Draghi told a news conference after a monthly rate-setting meeting that the 18-nation euro zone may experience a prolonged period of low inflation before a gradual return to the ECB's target level of just below 2 percent.

The central bank, which last shaved its main rate to 0.25 percent in November, “strongly emphasised” its willingness to act boldly if needed to prevent any slide towards deflation - a term it rejected - but left itself more time to assess price and money market trends.

“Overall, we remain determined to maintain a high degree of monetary accommodation and to take further decisive action if required,” Draghi said.

He acknowledged this was a more strongly worded expression than in the past of intent to act if money market interest rates rose too far or there was a further fall in the bank's inflation outlook.

“Right now, we don't see deflation,” he said, but a prolonged period of low inflation could entail downside risks. “By and large we don't see a deflation in the Japanese sense of the 1990s.”

The decision to hold rates unchanged was widely expected despite news earlier this week that euro zone inflation slowed to 0.8 percent in December, a development Draghi blamed on a one-off technical quirk in German service sector figures.

ECB watchers listening for any hints about the central bank's preferred tools for holding down market rates, which have begun to creep up as banks repay ECB loans, pulling liquidity stimulus from the system, gained little clarity.

Draghi said it was pointless to speculate what instruments the ECB might use. He would not be drawn on the possibility of outright purchases of securities similar to the quantitative easing policies of the US Federal Reserve, the Bank of England and the Bank of Japan, saying only that the ECB could do whatever its treaty mandate allowed.

With policy rates so low and the ECB's toolbox depleting, the threshold for further policy easing has risen, even as the central bank worries about slow price rises.

“We must be very careful that we do not permanently fall below 1 percent inflation and thus into the danger zone,” Draghi told German weekly Der Spiegel last week.

Economic recovery, while weak, has proceeded as the ECB has expected, giving it time to see whether inflation picks up.

 

LIQUIDITY

Low inflation is not the central bank's only concern. A lack of lending and receding excess liquidity - the amount of money in the market on top of what banks need for their day-to-day operations - are adding to its dilemma.

Excess liquidity - the money from ECB loans - almost halved overnight to 157 billion euros ($213.53 billion) as banks took up fewer funds from the ECB, which has reduced liquidity further by offsetting its bond purchases.

Early repayments of three-year central bank loans resume next week, meaning even more funds will be siphoned out of the markets, helping push money market rates up more.

Draghi has repeatedly said banks returning money to the ECB is a positive sign and has said interbank markets are working better. But if banks hoard less cash, borrowing costs rise.

Lending to companies in the bloc shrank at the fastest pace on record in November and the difference in corporate loan costs around the bloc grew. This suggests the ECB's low rates are still not filtering into all countries.

Nevertheless, Draghi said confidence was gradually returning to the euro zone economy and the central bank's very accommodative monetary policy stance was finally find its way into the real economy.

He acknowledged that some banks might be reducing lending to repair their balance sheets before the ECB conducts an asset-quality review of European banks starting next month.

But he said this would lead in the longer term to greater health of the banking system, a prerequisite for a sustained economic recovery. - Reuters


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