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ECB holds steady on rates amid inflation dilemma

January 19, 2017

The European Central Bank has kept interest rates at record lows and the terms of its landmark quantitative easing package unchanged as its president prepares to field questions on an economic outlook full of threats.

The bank’s governing council, meeting on Thursday in Frankfurt, left its benchmark main refinancing rate at zero. Its deposit rate, in effect a levy on reserves parked by lenders at eurozone central banks, stays at minus 0.4 per cent.

The bank still plans to buy a total of €780bn bonds this year under the QE package in place to steer the single currency area towards a stronger recovery.

“The governing council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases,” the ECB said, referring to its plans for QE.

Mario Draghi, European Central Bank president, will meet the press at 1.30pm UK time to field questions on the health of the region’s economy.

The bank is under pressure from economists to clarify why it decided to trim its quantitative easing package in December, despite the ECB’s own staff projections showing that eurozone inflation would remain below target for the period of its forecasts, which end in 2019. The bank plans to buy €80bn of bonds monthly in the first three months of this year, but said last month that it would cut the purchases down to €60bn in April through to the end of 2017.

The bank’s task in hitting its inflation target may become more complicated because of divergent price pressures within the region. At 1.1 per cent, inflation for the eurozone as a whole remains well below the ECB’s target of just under 2 per cent. But in Germany the rate stands at 1.7 per cent, compared with 0.5 per cent in Italy.

The ECB’s mandate allows inflation in the region’s strongest economies to exceed the bank’s target. But while price pressures in weaker member states remain subdued the bank looks set to come under pressure to raise rates from German lawmakers, who say low returns are penalising the country’s savers.

Serious risks still threaten the region’s recovery, including the threat of US protectionism and the weak balance sheets of some of Italy’s banks. Members of the ECB’s governing council have accepted that there are limits to the amount of assets they could buy — which has raised concerns that the bank will be unable to use further QE to counter another economic shock.

In Thursday’s statement, the ECB said that “if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the governing council stands ready” to increase QE’s size and duration.

Via FT