With Inflation Low, the European Central Bank Holds Rates Steady

8 years ago - October 03, 2013
The European Central Bank left its benchmark interest rate unchanged at a record low on Wednesday, but indicated it was ready to take steps if needed to protect the euro zone from political turmoil in the United States.

“The U.S. budget shutdown is a risk if protracted,” Mario Draghi, the central bank president, said at a news conference. But he added that he did not expect the two-day-old shutdown to last long.

Mr. Draghi deflected a question about what would happen if the United States defaulted on its debt because of the deadlock in Washington. He emphasized, though, that the bank was poised to intervene if needed.

“We have a vast array of instruments,” Mr. Draghi said. “And we exclude no option.”

But no immediate moves were announced. Meeting in Paris, the central bank’s governing council kept its main interest rate at 0.5 percent, where it has been since May.

In his news conference, Mr. Draghi repeated his assurance that the central bank would continue holding rates down, citing continued low inflation. He said the governing council had discussed a rate cut but remained divided on whether one was warranted.

Although the euro common currency is no longer under siege, tension in the euro zone has risen in recent weeks. There had been questions about the survival of the Italian government before Wednesday, when the opposition leader, Silvio Berlusconi, said he would support the government of Prime Minister Enrico Letta in a vote of confidence.

But the partial shutdown of the American government, depending on how long it continues, could undercut demand from the United States, the euro zone’s most important trading partner. Moreover, the political impasse in Washington raises the risk that the United States will hit the debt ceiling and begin defaulting on its debt. Analysts agree a default would be catastrophic for the world economy.

The euro zone has emerged from a recession that lasted a year and a half, but it is a feeble recovery that could easily be derailed by an external shock. “We view this recovery as weak, as fragile, as uneven,” Mr. Draghi said.

Europe has also been affected in recent months by expectations that the Federal Reserve in Washington would soon begin reducing its economic stimulus program — a move that, when it comes, is likely to push up market interest rates at a time when many European countries are experiencing severe shortages of credit.

Last week, Mr. Draghi said the European Central Bank would consider a fresh installment of unlimited three-year loans to banks at the rock-bottom official interest rate. The low-cost loans are the closest thing that the European Central Bank has to the “quantitative easing” employed by the Fed, and it helps make sure that banks have plenty of cash. On Wednesday, though, Mr. Draghi declined to be specific about when such a move might be coming.

A government shutdown in the United States affects Europe because it unsettles financial markets, and because it reduces demand in the American market that is crucial for European exports — everything from Italian Ferraris to French cosmetics.

“While the direct economic damage will probably be limited if government offices will be allowed to resume business after a couple of days, the political standoff will take its toll on sentiment,” Asoka Wöhrmann, co-chief investment officer of Deutsche Asset and Wealth Management in Frankfurt, said in an e-mail. “It is a bad harbinger for the upcoming — and potentially more serious — debt ceiling decision” in Washington.

In addition, the shutdown could weaken the dollar. That tends to hurt European exporters because their products become more expensive in dollar terms and have a more difficult time competing in the United States or other foreign markets. On Wednesday, prompted in part by Mr. Draghi’s resolve to keep rates low, the euro rallied to its highest level against the dollar since February, reaching a peak of $1.3606.

The European Central Bank has plenty of room to maneuver on monetary policy. Annual inflation in the euro zone fell to 1.1 percent in September, its lowest level in three and a half years and well below the bank’s target of about 2 percent.

The central bank is sworn to defend price stability above all else, and in theory it should be considering ways to increase inflation slightly. There remains a risk, however slight, that the euro zone could experience deflation, a broad decline in prices that undercuts corporate profits and investment and is associated with economic depression. Deflation can be more destructive than inflation, because it is very hard to reverse.

Mr. Draghi said inflation was in line with expectations and gave no indication the central bank was pondering measures to push inflation higher. “Inflation expectations for the euro area remain firmly anchored,” he said.


Text by The New York Times

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