Article Highlights

  • Policy unchanged
  • Draghi plays down recent economic weakness
  • Offers little clue about approaching decision on bond buys
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The European Central Bank kept policy unchanged on Thursday and ECB chief Mario Draghi played down concern over recent softness in the euro zone economy, leaving the door open to ending lavish bond purchases by the end of the year.

Having tweaked its guidance last month to reflect solid growth, Draghi argued that the economy remained strong, although he acknowledged evidence of a “pull-back” from exceptional growth readings seen around the turn of the year.

“Overall, however, growth is expected to remain solid and broad-based,” he told a news conference after ECB policy-makers held their meeting.

“The underlying strength of the euro area economy continues to support our confidence that inflation will converge towards our inflation aim of below but close to 2 percent over the medium-term.”

The euro rose 0.3 percent to $1.2197 as Draghi spoke.

With the 19-country bloc’s economy expanding for 20 straight quarters and millions of new jobs created, the main debate among policymakers is about how quickly to withdraw stimulus and preserve ECB firepower for the next downturn.

In particular, policymakers need to agree an end-date for the ECB’s 2.55 trillion-euro ($3.10 trillion) bond purchase program, which has cut borrowing costs and revived growth, even if it has failed to lift inflation back to target.

With Thursday’s decision, the ECB’s bond purchases, aimed at stimulating growth and inflation through rock-bottom debt costs, will continue at 30 billion euros a month at least until the end of September, or beyond if needed to prop up inflation.

The deposit rate, currently the bank’s primary interest rate tool, will remain at -0.40 percent. The main refinancing rate will stay at 0.00 percent.

Economists polled by Reuters ahead of the meeting expected bond purchases to end this year after a short taper and to see the first rate increase in the second quarter of 2019. Some, however, have started to flag risks of a delay.

Their 2018 growth forecasts were unchanged at 2.3 percent, but most economists polled said the trade dispute between the United States and China would also damage the euro zone economy .

TRADE WAR?

With the bond-buying scheme due to expire in September, the ECB will have to decide in June or July whether to extend purchases or wind them down. But with the risk of a global trade war still looming, it may not decide until absolutely necessary, retaining the flexibility to adjust policy.

Business sentiment has already taken a hit, particularly in export-focused Germany, and a full-fledged trade war could quickly hurt growth — a risk already highlighted by policymakers at the ECB’s March meeting .

One worry is that protectionist rhetoric from the United States could push down the value of the dollar, an economic anomaly as the Federal Reserve is likely to raise interest rates several times this year, a natural support for its currency.

While U.S. 10-year yields hit 3 percent this month for the first time since 2014, German yields — now around 0.61 percent — have barely edged up this year, suggesting that any ECB normalization will be extremely slow.

A stronger euro would cap inflation, a headache for the ECB. Inflation is already set to miss its target of near 2 percent, the central bank’s sole policy objective, for years to come.

Euro zone inflation is so weak that even after the creation of 9 million jobs since early 2013, measures of underlying price growth that strip out energy and food are barely rising.

This suggests that the euro zone’s economic downturn was more severe than earlier thought and makes the recovery even more protracted.

The impact of the euro’s strength has been relatively so far, however. The currency is up 1.5 percent against the dollar this year and just 0.3 percent higher on a trade-weighted basis.

Even if the currency impact were to bite, the ECB has little scope to extend purchases much longer, suggesting it will take an extremely cautious approach to normalizing policy, even if it risks erring on the side of caution and moving too late.