ECB says rates low 'for extended period'

AP News
Posted: Jul 04, 2013 12:25 PM
ECB says rates low 'for extended period'

FRANKFURT, Germany (AP) — The European Central Bank and the Bank of England on Thursday underlined their determination to keep interest rates low in an attempt to reassure markets unsettled by the possible end of the U.S. Federal Reserve's bond-buying program.

Abandoning a longtime practice of saying it "never precommits" on interest rate decisions, the ECB said it would keep its benchmark interest rate the same or lower "for an extended period of time."

The statement followed a meeting of the bank's rate council which left the refinancing rate for the 17 European Union countries that use the euro unchanged at 0.5 percent.

Draghi said the decision followed "an extensive discussion" of a potential rate cut.

Instead of a cut, the bank offered what is called "forward guidance". The practice — already used by the U.S. Federal Reserve — is designed to give markets clarity about central bank's future course of action in order to influence and reassure markets.

The Bank of England did something similar at its monthly meeting Thursday. Under new governor Mark Carney, the bank issued a statement saying that expectation of a rate rise "was not warranted". The Bank also kept its main interest rate at 0.5 percent.

Markets reacted dramatically to the two banks' statements. In London, the FTSE 100 index of leading shares closed up 3.1 percent, while Germany's DAX stock index ended Thursday 2.11 percent higher. Both the euro and pound fell on the two banks' actions as investors moved their investments to currencies with a higher return.

The goal of the ECB and the Bank of England was to keep bond market interest rates from rising and hurting economic growth through higher borrowing costs. Market rates have crept up since the Fed signaled last month it could begin phasing out its bond-buying program this year.

The Fed program — known as quantitative easing — has been sending fresh money into financial markets, driving bond prices up and keeping borrowing costs down. Word the Fed might scale back soon sent this into reverse.

Analyst Christian Schulz called the ECB guidance a "mini-revolution" because the central bank abandoned its longstanding catchphrase that it "never precommits" on its policies.

"This is a weak form of forward guidance. But it is guidance nonetheless," Schulz wrote in a note to investors.

At his news conference following the ECB meeting, Draghi rebuffed attempts by journalists to pin him down about what an extended period meant just saying "an extended period of time is an extended period of time."

He also did not specify any concrete targets for unemployment or growth, as the U.S. Fed has done. The U.S. central bank has said its rates will remain near zero until unemployment falls to 6.5 percent.

Still, Draghi was clearly at pains to show the bank as leaning toward doing more to help stimulate the eurozone. The ECB president said the current record low benchmark rate of 0.5 percent "is not the lower bound." He added that the bank's statements were intended "to inject a downward bias in interest rates for the foreseeable future."

The ECB added that rates would remain low so long as three conditions continued to exist: no threat of inflation, weak economic output, and anemic lending by banks. But no figures were mentioned.

The eurozone economy has struggled due to the region's government debt crisis which has forced countries to cut back on spending and raise taxes to try to reduce levels of debt. Economic output shrank 0.2 percent in the first quarter, the sixth quarterly decline in a row.

Growth is key to getting the eurozone out of its problems. An expanding economy increases government tax revenue as people and businesses earn more. And it reduces the size of debt relative to the size of the economy.

In theory, a low interest rate could stimulate the economy by reducing borrowing costs on the loans businesses need to expand and create more jobs.

Yet the currently low refinancing rate - the rate the ECB charges private sector banks to borrow - is not being passed on by banks. That is because banks themselves often have strained finances and are keeping money back to meet new regulatory requirements aimed at strengthening the financial system.

So there is skepticism among economists and ECB leaders themselves about how much good another rate cut will do. The bank has already cut interest rates, made cheap three-year loans to banks, and offered to buy the government bonds of indebted countries in the open market if they promise to reform their finances.

Much attention has focused instead on tools the ECB could use beside rate cuts to try to get the economy going again. Forward guidance was one of those.

The bank has also said it is looking at ways to promote lending to small companies, working in cooperation with other EU institutions. However the ECB cannot do that alone. It would take months to set up measures — such as bundling small business loans into securities which could then be sold off — so that more money could be freed up for banks.