European Central Bank President Mario Draghi has underlined the bank’s determination to stick with stimulus for the struggling eurozone, saying the bank will 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%. Mr Draghi said the decision followed “an extensive discussion” of a potential rate cut.
Instead, in a marked departure of its usual stance of never pre-committing itself to targets, the bank offered an attempt at what is called “forward guidance”. The practice – already used by the US Federal Reserve – is designed to give more clarity about how long a central bank will continue its measures to stimulate the economy.
Also today after its monthly policy setting meeting, the Bank of England issued its own form of forward guidance. In his first policy since taking over the bank, new governor Mark Carney issued a statement saying that expectations of a rate rise “was not warranted”.
Markets reacted dramatically on the banks’ statements. In London, the FTSE 100 index of leading shares was up 3%, while Germany’s DAX stock index was up 2.16%t. Meanwhile, the pound and the euro fell against the dollar.
At his news conference following the ECB meeting, Mr Draghi rebuffed attempts by journalists to pin him down about what an extended period meant. Asked if it meant six or 12 months, he said, “an extended period of time is an extended period of time.”
He did not specify any concrete targets for unemployment or growth.
The ECB provided additional guidance by saying that rates would remain low so long as three conditions continued to exist: no threat of inflation, weak economic output, and anaemic lending by banks. But again, no figures were mentioned.
Still, Mr Draghi was clearly at pains to show the bank as leaning toward doing more to help stimulate the eurozone. The region’s economy shrank 0.2% in the first quarter, the sixth quarterly decline in a row.
The eurozone economy has lagged due to the government debt crisis which has forced countries to cut back on spending and raise taxes to try to reduce debt. 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.
The ECB president said the current record low benchmark rate of 0.5% “is not the lower bound” and added that the bank’s statements were intended “to inject a downward bias in interest rates for the foreseeable future.”
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 scepticism among economists and ECB leaders themselves about how much good another rate cut will do.