The European Central Bank left interest rates at 1 per cent on Wednesday, dashing some market expectations that it might move quickly to combat fears about the health of the euro zone.
Markets were unsure how the ECB would react to the recent wave of weak economic data, knowing that the bank also wants to keep the pressure on euro zone leaders to tackle the crisis more effectively.
“I can imagine that the market is a little disappointed that they didn’t cut rates,” said Rabobank economist Elwin de Groot.
“It had been pricing some action on this front. Eonia swap rates have been trading at 0.272 so the key question for the market now is whether the ECB will cut rates next month and whether it is willing to also lower the deposit rate.”
The euro was steady at $1.25 after the decision, Europe’s benchmark stock market trimmed gains, while closely watched German bund future were also little changed.
Focus now flips to the ECB’s 1230 GMT news conference where head of the bank, Mario Draghi, will detail the decision, give its latest assessment of the euro zone’s troubles and lay out any additional support that it plans to put in place.
It is widely expected to announce a lengthy extension to banks unlimited access to ECB loans, while experts are also looking for any hints of another injection of 3-year funding and a further loosening of its lending rules to ensure troubled banks can get ECB money.
Mr. Draghi will also give the ECB’s latest economic forecasts. Recent troubles are expected to see them revised down from the last set in March when 2012 growth was seen between -0.5 and +0.3 per cent and inflation forecast between 2.1 and 2.7 per cent.
Whilst the ECB is widely seen as the only institution capable of immediate action on behalf of the euro zone, Mr. Draghi and the rest of the ECB are urging governments to ditch their gradualist approach and address the euro zone’s crisis head on.
But with the bloc being rocked by fears that debt strained Greece may have to quit the euro and by a slow motion banking crisis playing out in Spain, the central bank is facing pressure to help out from all sides.
In the run up to the meeting, the head of the IMF Christine Lagarde, said the bank had room to cut rates. Spain and other hard hit parts of the euro zone would also like the ECB bond buying to provide them with cover while they undertake planned repairs to their economies.
The bank’s dilemma is that if does too much, pressure for government action falls. Yet if it does nothing, troubled sovereign debtors could find it harder and harder to finance themselves or maintain confidence in the banks that have bought much of their debt.
PAIN IN SPAIN
The respite the ECB had bought markets at the beginning of the year by injecting more than 1 trillion euros into the euro zone’s banking system with twin 3-year loan operations, is fading fast with borrowing costs for troubled countries once again soaring.
Euro zone unemployment stood at a record 11 per cent in April, business confidence has slumped and surveys of manufacturing have hit three-year lows, adding to conviction that the bloc’s economy is set to drop back into recession.
Most ECB watchers had expected it would keep its weapons holstered until after Greek elections and a crunch summit of EU leaders at the end of June, which Mr. Draghi and his colleagues hope will dispel any doubts about Europe’s commitment to the euro.
Spain said on Tuesday that it was getting priced out of credit markets. Finance chiefs of the Group of Seven major economies held emergency talks as the debt crisis honed in on the bloc’s fourth largest economy, whose autonomous regions have overspent and whose banks and homeowners are laden with bad debts from a burst property bubble.
Despite Spanish pleas for the ECB to restart its bond-buying programme, Mr. Draghi is likely to stick unflinching to his line that the programme is still ongoing - even though the central bank has not bought any bonds in the past three months.
However, one measure it could take on a short notice is to further loosen the rules against which it lends funds to banks. This would open up reliable funding to banks that are being shunned by other lenders in the money market - but even here, the ECB wants to wait until after the summit.