European Central Bank leaves benchmark interest rate at 0.25 per cent but says ready to act

FRANKFURT – The European Central Bank is ready to take “decisive action” and use its full range of policies to keep the euro bloc from sliding into crippling deflation, President Mario Draghi said Thursday.

The ECB took no new steps at its monthly policy meeting, leaving its key interest rate unchanged at a record low of 0.25 per cent. Draghi said it would be “pointless” to speculate now exactly which tool the bank might use.

Yet his language, promising easy monetary conditions and “further decisive action if required,” underlined the bank’s commitment to keep the eurozone out of a deflationary spiral, in which falling prices choke off growth. That’s what happened for years in Japan, and it’s a trap that can be hard to get out of.

He said the bank would use any means allowed. In theory, that also includes injecting new money into the economy, as the U.S. Federal Reserve has done, though such a move would run into strong opposition from Germany, the eurozone’s largest member.

“To counter the impression that the (ECB) lacked the stomach for the fight to preserve price stability, it chose to introduce more muscular language,” said Richard Barwell, an economist at RBS

Draghi repeated the bank’s reassurance that it intends to keep interest rates at current or lower levels for an extended period of time to spur growth and avoid a fall in prices.

The 18-country eurozone’s economy grew only 0.1 per cent in the third quarter, and unemployment is at a record of 12.1 per cent. Crucially, inflation is only 0.8 per cent, far below the ECB’s goal of just under 2 per cent.

Draghi dismissed fears that the eurozone would succumb to deflation: “We are not in a Japanese scenario.”

Still, it’s clear that the ECB is in a very different place compared with the Fed, which is already phasing out its stimulus efforts as the U.S. economic recovery strengthens.

“It seems unlikely that the ECB’s work is done,” said Jonathan Loynes, chief European economist at Capital Economics.

Markets seemed to believe so, with investors pushing the euro from $1.3630 before Draghi’s comments to $1.3570 afterward. Looser monetary policy tends to weaken a currency.

Analysts say the ECB has various options, though each as its drawbacks.

It might offer cheap loans to banks on conditon that the money is loaned to companies. That would provide more credit so businesses can expand and hire people. But some ECB officials appear hesitant to do so, warning it would interfere with banks’ free market decisions.

Cutting the main interest rate further in theory would help growth, but the rate is already low.

The ECB could also penalize banks for hoarding funds in the form of deposits at the ECB, charging them a negative interest rate. But banks might just pass the costs on to customers.

On paper, the ECB would also be allowed to purchase financial assets such as government bonds with newly created money, similar to what the U.S. Federal Reserve has done. That can increase the supply of money in the economy and push up inflation.

But ECB officials have indicated such a move could be complicated given the different bond markets in the currency union. It could also face political opposition from Germany, where many officials and economists are skeptical of central bank activism.