ECB reacts to recession threat by keeping interest rates low

The European Central Bank has reacted to the threat of recession across the eurozone with a promise to keep interest rates at historically low levels for at least the rest of the year.

Highlighting the dramatic effect of Donald Trump’s trade war with China on Europe’s manufacturing industry, the ECB president, Mario Draghi, said he would also offer cheap loans to the eurozone’s troubled banks, which need to roll over billions of euros of funding over the next two years.

The announcement came as the ECB sharply cut its eurozone growth forecasts for 2019 from 1.7% to 1.1%.

It also surprised financial markets, which expected the ECB to wait for a few more months of economic data before easing its lending policy.

Traders pushed down the value of the euro and increased the value of eurozone sovereign debt, as the prospect of low interest rates for a longer period become clear.

The euro dropped to a three-week low and bank shares bounced back from the lows of last month. The euro was down 0.3% against the dollar to $1.1275 at 1.10 pm GMT.

The Italian government was one of the main beneficiaries. The interest rate it pays on its debts, which are the largest in Europe, were reduced by traders. Italian banking stocks rose as much as 1% immediately after the ECB decision was announced.

The ECB action followed an effective freeze on interest rate rises by the US Federal Reserve and the Bank of England as policymakers have reacted to a global slowdown.

Central banks have halted sales of sovereign bonds and frozen rates because of concerns that rises were threatening to plunge their economies into recession.

Draghi said growth across the eurozone slipped to 0.2% in the final quarter of 2018, half the rate recorded in the first two quarters.

The outlook for the next 12 months had deteriorated after a series of shocks to the global economy that were likely to persist through 2019, he said.

Draghi highlighted the cut in the forecasts for China’s growth and the uncertainty over Brexit as being among several factors dragging down growth in the eurozone.

The outlook for GDP growth this year has been revised down substantially after significant slowdowns in Italy, Germany and to a lesser extent France.

Draghi said the ECB governing council judged the prospect of a recession to be “very low” after moves by governments to bolster their economies this year, adding: “Our actions increase the resilience of the eurozone economy.”

But analysts said downturns across the eurozone had threatened to turn into recessions without action from individual governments and the ECB.

The central bank for the 19 euro nations said it would launch a series of targeted, long-term refinancing operations (TLTROs) in September. These are to run until March 2021 to help banks roll over €720bn (£617bn) of ECB loans and to ward off a credit squeeze that could deepen the economic slowdown.

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Karen Ward, a market strategist at JP Morgan Asset Management, said the ECB was following in the footsteps of the Fed in turning dovish.

“Following a significant pivot from the US Federal Reserve in recent months, the ECB followed suit by providing ongoing liquidity support to the eurozone’s banks. It also changed its forward guidance such that rates will remain at or below current levels at least through the end of 2019.

“This should help stabilise sentiment and activity in the eurozone. But for a meaningful turnaround in Europe we look further afield to what’s happening in Beijing. In our view a notable rebound in activity in China is required to see a significant reacceleration in Europe over the course of the year.”

The Bank of England official Silvana Tenreyro opened up a split on the monetary policy committee following comments that the UK’s central bank was under little pressure from inflation to push up interest rates and would most likely be forced to cut the cost of borrowing should the UK crash out of the EU in the next few weeks.

The Bank has said its response to a chaotic exit would not be automatic because a fall in the value of the pound and the imposition of tariffs on trade could push up inflation, making the case for a rate hike.

Echoing Draghi’s dovish comments, she said: “In my judgment, a situation where the negative demand effects outweigh those other effects is more likely, which would necessitate a loosening in policy.”


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