ECB closes door on rate cuts but warns of weak inflation

TALLINN (Reuters) - The European Central Bank closed the door on more interest rate cuts on Thursday, judging the euro zone economy to be rebounding, but said inflation looks to remain weak for years so it still needs to pump out the cash.

The currency bloc has been on its best economic run since the global financial crisis nearly a decade with millions of jobs created since the ECB’s stimulus effort started. But inflation is barely moving upwards and growth may be plateauing, putting the ECB into a difficult spot.

Acknowledging improved prospects, the ECB dropped a pledge to cut rates if necessary and gave up a long-standing reference to risks to the economy, declaring the outlook “balanced”.

Yet rate setters did not even discuss winding down the ECB’s 2.3 trillion euro ($2.6 trillion) asset purchase scheme, kept rates below zero, and pledged very substantial accommodation.

The ECB also cut most of its inflation projections, even as it predicted better growth, suggesting that it has been overestimating the impact of rapid job creation on wages and ultimately prices.

“We consider that risks to the growth outlook are now broadly balanced,” ECB President Mario Draghi told a news conference in the Estonian capital of Tallinn.

He said the bank removed the language about potentially lowering interest rates because ultra-low inflation risks have gone.

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“(But) if these risks were to reappear, we would certainly be ready to lower rates,” he said.

With Thursday’s decision, the ECB’s deposit rate, its key policy tool, remains at -0.4 percent. Its monthly asset purchases will continue to total 60 billion euros a month and to run until at least December.

The euro EUR= hit a one-week low of $1.11995, down around 0.4 percent on the day, as Draghi spoke.


Playing down the significance of its new guidance and the forecast cuts, Draghi said the general path of inflation has not changed and rate cuts are not impossible, giving his message a dovish tilt.

“Nothing substantial has happened to inflation except the price of oil and the price of food ... underlying inflation has remained the same year to year,” he noted.

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The next major test will come in September, when the bank will probably decide whether to continue bond buys beyond this year or start to wind them down, known as tapering.

“There is a growing risk that tapering is slower and takes longer than the market currently expects,” Cosimo Marasciulo, a bond manager at Pioneer Investments said.

The ECB said it now saw inflation this year at just 1.5 percent, down from a previous forecast of 1.7 percent and still short of its target of close to 2 percent.

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That would barely rise to 1.6 percent in 2019, down from an earlier estimate of 1.7 percent and further away from its official target of at or close to two percent.

Economic growth this year was seen at 1.9 percent versus an earlier 1.8 percent forecast.

That came after the EU statistics agency Eurostat earlier revised up its estimate of first quarter growth to its fastest rate in two years, saying the economy of the 19-country euro zone expanded by 0.6 percent quarter-on-quarter and by 1.9 percent year-on-year.

The ECB’s nuanced stance was also motivated by the big debts overhanging governments and companies, the piles of unpaid loans weighing on banks in countries like Italy and Portugal, and political uncertainty ahead of elections in Germany and Italy.

Any announcement on its quantitative easing (QE) program is seen not coming until the autumn, when policymakers hope the economic picture will have become clearer.

German politicians in particular have called for an earlier end to QE, saying it is eroding the assets of savers and discourages other eurozone countries from pursuing reforms to make their economies more efficient. However Draghi there were no visible divisions at the Governing Council’s meeting.

“I didn’t hear any dissenting voice ... with respect to the proposals,” he said.

Additional reporting by Michael Nienaber; Writing by Mark John and Balazs Koranyi; Editing by Jeremy Gaunt