FRANKFURT Jan 22 The European Central Bank
appears content to sit on its hands in the hope recovery unfolds
as neither of the red flags which could prompt it to act are
waving vigorously enough to worry it.
Earlier this month, ECB President Mario Draghi stepped up
his rhetoric, saying the central bank "strongly emphasised" its
accommodative stance and would take "decisive action" if
inflation undershoots or money market rates tighten in a way
that tightens policy by stealth.
At the same time, he said the bank's policies were bearing
fruit, with loose policy "finally finding its way through the
economy" - an indication, some say, that the ECB hopes to wait
this one out without major action.
As with Draghi's much vaunted and still-unused bond-buying
programme, which did so much to underpin the euro zone when he
announced it in 2012, the hope is that the threat of action will
The start of the year has certainly seen signs of confidence
returning to the currency bloc.
Irish, Spanish and Italian five-year sovereign bond yields
have all hit record lows this month and euro zone manufacturing
grew in December at the fastest rate since mid-2011.
"In the absence of further deterioration of market and
inflation conditions, hopes of actual further policy easing
near-term may prove optimistic," G+ Economics' Lena Komileva
said. "The bar to future policy action is probably higher than
Importantly, hawkish policymakers including Bundesbank
President Jens Weidmann, have stuck to Draghi's script.
Consensus - often elusive in the past - makes the ECB's
pledge more convincing, which in turn helps keep a lid on the
euro exchange rate and dampens upward pressure on market
Of the two factors potentially forcing the ECB's hand -
inflation too low or market rates too high - the latter has
received much more coverage. In the last quarter of 2013,
inflation averaged only 0.8 percent, way below the ECB's target
of just under 2 percent.
Draghi has spoken of a "danger zone" below 1 percent, where
the cushion against disinflation is uncomfortably small.
At the same time, the ECB has rejected any suggestions that
the euro zone would slip into a deflationary spiral as it sees
gradual recovery and returning confidence boosting price growth
back towards target.
A downgrade to ECB staff inflation forecasts, which will be
reviewed in March, might not be enough for the ECB to act as the
governing council's view might differ.
Economists agree with the ECB's assessment. In a recent
Reuters poll, 37 of 44 economists saw a prolonged period of low
inflation, but no deflation.
While Greece and Cyprus already have negative inflation
rates and Portugal, Spain and Ireland are on the brink,
gathering economic momentum in all three will lower the risk of
persistently falling prices.
"What matters the most is that as long as the growth
recovery remains on track, in the medium term core prices are
unlikely to decouple from economic activity and enter dangerous
territory," Unicredit economist Marco Valli said.
An unwarranted rise in market interest rates has become a
more likely trigger for action. If all else is left equal, the
ECB's policy stance will tighten gradually as banks pay back
The central bank could counter that by offering more cheap
loans but policymakers have tempered such expectations.
Money-market traders do not foresee the ECB flooding the markets
for at least the next six months, a Reuters poll showed on
Later in the year, however, any nasty surprises from the
ECB's bank stress tests could push it to pump cheap cash to the
markets to ward off a credit crunch.
For now, the ECB seems to have no big issue with volatility
in overnight rates, which have climbed to top the refi
rate in recent days. The ECB said reduced liquidity makes
interpreting money-market rates more complex, which in turn
increases uncertainty about its pain threshold.
Moreover, whenever short-term rates have risen, banks have
turned to the ECB for more funds, which has pushed them back
More profound is the argument is that banks paying back
their ECB loans and market rates rising is a sign of returning
confidence in the financial system.
"The benefits of this normalisation in terms of reduced
fragmentation are much higher than the costs, so we don't see
any reason for the ECB to act at the moment," Barclays Fixed
Income Strategist Guiseppe Maraffino said.
(Editing by Mike Peacock)