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ECB Joins Global Trend As Governing Council Discusses Rate Cuts

ecb dragi 030817 06jun19 lt

The European Central Bank turned dovish as expected in June, with the bank chief Mario Draghi confirming that the bank no longer has a rate-hike bias and that several policymakers raised the possibility of a deposit rate cut in the near future, as the global trade tensions hurt the economic sentiment in Eurozone.

By turning dovish, the ECB has joined the league of central banks across the world who have already cut interest rates, or see such a move in a year's time, as the escalating trade tensions have raised the prospect of a recession in the global economy.

Federal Reserve Chairman Jerome Powell said on Tuesday that the central bank will take appropriate actions to sustain the U.S. economic expansion.

Powell's comments came after St. Louis Fed President James Bullard suggested in a speech on Monday that an interest rate cut "may be warranted soon" due in part to escalating global trade tensions.

Central banks in Australia, New Zealand, India, Malaysia and Russia, among others, have cut interest rates this year, while others like Norway and the UK are planning to hike.

The scenarios are different in different countries, Draghi told reporters in the Lithuanian capital Vilnius after the policy session.

"The Governing Council is determined to act in case of adverse contingencies and also stands ready to adjust all of its instruments, as appropriate, " Draghi asserted.

Bank of England Governor Mark Carney has repeatedly said that a gradual and limited rise in interest rates may be needed in case of a smooth Brexit.

The global economy could slip into recession in nine months if the Donald Trump administration pushes ahead with a 25 percent hike in tariffs on the final US$300 billion of Chinese imports and triggers retaliation from China, Morgan Stanley Chief Economist Chetan Ahya said in a note at the start of the week.

And, economists at Goldman Sachs predicted that the likelihood of the US following through its threat has risen to 60 percent from 40 percent.

The trade conflict is not limited to just raising tariffs. Big companies with operations in both US and China are being targeted by the respective governments.

The ECB left interest rates unchanged on Thursday and extended its forward guidance to reflect its view that rates will remain at the present level at least through the first half of 2020.

Earlier, the bank expected rate to remain unchanged at least till the end of this year.

A mild change to the forward guidance in March had suggested that the bank expects the first interest rate hike since the financial crisis to take place in 2020. The latest wording has clarified the message.

Eurozone interest rates were raised last in July 2011 by 25 basis points.

ECB President Draghi said the forward guidance was extended, considering the prolongation of uncertainties. The latest decision was unanimous, he added.

"Despite the somewhat better than expected data for the first quarter, the most recent information indicates that global headwinds continue to weigh on the euro area outlook," Draghi said.

"The prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is leaving its mark on economic sentiment."

The ECB chief said several Governing Council members raised the possibility of cutting the deposit facility rate, which is already in negative territory, at minus 0.40 percent.

Others raised the prospect of restarting the asset purchase programme or the extension of forward guidance, he added. However, policymakers did not discuss which contingency would call for which instrument, Draghi said.

"The Governing Council also assessed that, at this point in time, the positive contribution of negative interest rates... is not undermined by possible side effects on bank-based intermediation," Draghi said.

"However, we will continue to monitor carefully the bank-based transmission channel of monetary policy and the case for mitigating measures."

The ECB staff cut the euro area growth forecast for this year was raised to 1.2 percent from 1.1 percent seen in March.

The outlook for next year was slashed to 1.4 percent from 1.6 percent and the forecast for 2021 was cut to 1.4 percent from 1.5 percent.

"The risks surrounding the euro area growth outlook remain tilted to the downside, on account of the prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets," Draghi said in his introductory statement.

While the weakness in the global trade is weighing on the euro area manufacturing sector, services and construction sectors are showing resilience and the labor market keeps improving, Draghi noted.

The bank raised the inflation projection for this year to 1.3 percent from 1.2 percent on favorable monetary policy pressures and stronger wage growth.

However, the projection for next year was cut to 1.4 percent from 1.5 percent and the outlook for 2021 was left unchanged at 1.6 percent.

The ECB also detailed the terms of its latest targeted longer-term refinancing operations, or TLTRO III, announced in March.

The Governing Council priced these longer term loans, with a maturing of two years, 10 basis points above the average rate in the main refinancing operations.

"For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III will be lower and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation plus 10 basis points," the ECB said.

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