The worst days of the European economic crisis may be over, but the European Central Bank isn’t breaking out the champagne as old threats remain and new threats such as falling inflation rates emerge.
At a press conference Thursday immediately after the ECB left its benchmark interest rates intact at record lows, bank president Mario Draghi said it is “premature to declare victory” in the battle to end the crisis.
“The recovery is there, but it is weak and modest,” he said, insisting that rates would remain at rock-bottom levels for a long time. The ECB’s benchmark rate was left intact at 0.25 per cent.
Mr. Draghi cited the “unacceptably high unemployment rate” in the euro zone – it was 12.1 per cent at last count – and the political and economic risks that could undermine the tentative recovery. The 18-country euro zone (Latvia became the newest user of the euro on Jan. 1) is out of recession, but overall growth remains weak.
He is also clearly concerned about price stability, noting that “we may experience a prolonged period of low inflation.”
Euro zone inflation in December was running at 0.8 per cent, well below the target rate of just under 2 per cent. Core inflation, which excludes typically volatile food and energy prices, was 0.7 per cent, a record low.
The ECB cut rates by a quarter of a point in November, after the headline inflation rate dropped to 0.7 per cent, leading to fears of outright deflation – falling prices – which can be devastating to an economy. If consumers think items such as appliances will be cheaper in six months or a year, they will delay their purchases.
But Mr. Draghi gave no hint on Thursday that the odds of deflation were on the rise. He suggested that the December figure was a statistical anomaly, a hint that the January inflation figure may be higher. “We are not in a Japanese scenario,” he said, referring to the so-called lost decade in Japan, when prices fell and the economy went nowhere.
The ECB’s holding pattern was widely expected and came shortly after the Bank of England kept its benchmark rate unchanged at 0.5 per cent and its £375-billion ($670-billion) asset-purchase program intact even though the British economy appears to be gaining strength by the day. Bank of England governor Mark Carney has said rates are unlikely to rise until the jobless rate drops to 7 per cent.
While Mr. Draghi’s comments were similar to the ones he made a month ago at the last ECB rate-setting meeting, there is no doubt the bank is on heightened alert about the risks of deflation or an economic slowdown. He said, “over all, we remain determined to maintain a high degree of monetary accommodation and to take further decisive action if required.”
ING Financial Markets economist Carsten Brzeski said the message was “a clear sign that the ECB is not leaning back to relax, but remains on high alert.”
Mr. Draghi would not say what instruments the ECB would employ in the face of deterioration, but economists think he would resort to “non-standard” measures. These measures might include another round of liquidity injections into the banking system under the LTRO – long-term refinancing operation – last used two years ago in an attempt to end the credit crunch and keep banks lending.
The ECB’s decision came as more evidence emerged that the European economy is improving, though the growth rates are anemic and far below those of the United States and Britain. Two bailed out countries, Ireland and Portugal, are returning to the bond markets.
On Thursday, just before Bank of England and ECB rate announcements, fresh data revealed that German industrial production rose 1.9 per cent in November, month on month, after a 1.2-per-cent drop in October. Over the year, German industrial production was up a strong 3.5 per cent. “The combination of richly filled order books and low inventories bodes well for [German] industrial production in the coming months,” Mr. Brzeski said.
Euro zone economic sentiment is also on the rise. The region’s economic sentiment indicator rose to its highest level since July, 2011, putting it back in line with its long-term average. Especially large sentiment increases were recorded in Italy, Spain and Portugal, three countries that were hit hard by the crisis. ING said the rise indicates that growth probably accelerated in the last quarter of 2013.