The euro zone economy shows little sign of recovering before the year-end despite easing financial market conditions, European Central Bank President Mario Draghi said on Thursday, leaving open the possibility of an interest rate cut in the months ahead.
But after keeping rates on hold on Thursday, Mr. Draghi said the ECB cannot do much more to help Greece with its debt burden and gave Spain none of the assurance it wants that ECB bond buying will lower its borrowing costs.
“The ECB is by and large done,” Mr. Draghi told his monthly news conference when asked what the bank could do for Greece.
The euro zone is grappling to find a formula to make Greek debt sustainable, with Germany and the International Monetary Fund at odds over the need for governments and the ECB to take a “haircut” on Greek bonds they hold to make the numbers add up.
The ECB agreed earlier this year to hand over to euro zone governments profits on its Greek bonds but has refused to take a hit on the value of the paper, saying that would be “monetary financing” which it is prohibited from doing.
The ECB held its main rate at 0.75 per cent, deferring any cut while it waits for a cue to use its new bond-purchase plan. That wait may be prolonged after Spain completed its 2012 funding at affordable rates on capital markets on Thursday.
A Reuters poll had given an 80-per-cent chance the ECB would hold its main rate, but most of the 73 analysts polled expect it will be cut to a new record low of 0.5 per cent within the next few months.
Mr. Draghi said ECB monetary policy is “very accommodative.” He declined to comment when asked whether markets were right to expect a rate cut next month and said the policy making Governing Council had not discussed what it would do next year.
Economist Howard Archer at IHS Global Insight said: “[Mr.] Draghi appeared to ease open the door to a cut in interest rates over the coming months and potentially as soon as December.”
Not everyone expects a cut that soon.
“Our sense is that the ECB is firmly on hold,” said JP Morgan economist Greg Fuzesi, though he added: “Next year, the ECB will act if growth disappoints more fundamentally.”
Describing “a picture of weaker economies” in the euro zone, Mr. Draghi said this would influence new ECB economic forecasts due next month. Inflation would remain above the ECB’s target for the rest of the year, before falling below 2 per cent in 2013.
“We certainly continue monitoring economic activity and we stand ready to act,” he said.
“We stand ready to act with OMT (bond-purchase plan) once the prerequisites are in place. We also stand ready to act with the rest of standard, normal monetary policy instruments.”
Recent survey evidence gave no sign of improvement towards the year-end and the risks surrounding the euro area remain on the downside, Mr. Draghi said. As he spoke, the euro fell against the dollar and hit a session low in early New York trade.
Gloomy data this week indicated the euro zone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates.
Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the euro zone, a mechanism that has been broken by the bloc’s debt crisis.
The new bond-purchase plan – dubbed Outright Monetary Transactions (OMTs) – is the ECB’s designated tool for this but can only be activated once a euro zone government requests help from the bloc’s rescue fund and accepts policy conditions and strict international supervision.
So far no request has been made, but the announcement of the policy alone has calmed markets.
“We are ready to undertake OMTs which will help to avoid extreme scenarios, thereby clearly reducing concerns about the materialization of destructive forces,” Mr. Draghi said.
Asked whether he could imagine an extreme scenario in which the bank began buying bonds without conditions, he said the answer was ‘no’.
Investors and euro zone policy makers have been urging Spain to seek aid but Prime Minister Mariano Rajoy has so far held off a request, saying he wants assurances that ECB intervention would bring down Spain’s debt costs.
Mr. Draghi gave Mr. Rajoy no comfort.
“The Governing Council will take the final decision in total independence,” he said of any decision on whether to use the OMT programme. “In so doing, it cannot give any assurance ex ante.”
Spain sold €4.8-billion of debt including its first longer-term issue in 18 months on Thursday, enough to complete its 2012 financing program and begin raising funds for next year. So there is little immediate pressure on that front.
Yields on Spanish government bonds have dropped by around 2 percentage points since Mr. Draghi said in late July the ECB was ready to do “whatever it takes to preserve the euro” – a pledge that heralded the bond-buying plan.
Investment funds have started flowing back into the euro zone since then, particularly from U.S. money market funds, Mr. Draghi said.
Some economists have now raised the possibility that the OMT might never have to be activated considering its impact so far.
But Matteo Cominetta, European economist at UBS, said it would eventually be put to the test because of the large amount of Spanish sovereign debt coming up for refinancing next year, roughly €140-billion according to Reuters data.
“Next year, you will have a record supply of Spanish bonds up for renewal in a situation where macro economic data will remain very bad for a long time in Spain,” Mr. Cominetta said.
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