European Central Bank leaves rates at record low 0.75 per cent as eurozone economy lags

FRANKFURT – European Central Bank President Mario Draghi says the euro area’s struggling economy is showing early signs of improvement and should grow modestly by the end of 2013 but it is not out of the danger zone yet as it struggles with recession and too much debt.

The group of 17 European Union countries that use the euro will recover gradually later this year, he said — if governments get moving on making their economies more business-friendly.

Draghi spoke after the bank’s 23-member governing council left its key interest rate unchanged at a record low of 0.75 per cent. The ECB chief ticked off a list of improvements in the eurozone’s battle to overcome its financial and economic crisis to back up his forecast that the eurozone is beginning the path to recovery.

They included lower bond market borrowing costs for governments, rising stock markets, and a flow of deposits back into banks in the most troubled countries. The ECB chief also pointed to recent indicators such as polls of purchasing managers and German business executives.

Recent indicators “have broadly stabilized,” although at low levels, he said, and financial markets have steadied. “Economic activity should gradually recover” later this year, he said.

But, he added, “to define a turning point you need a lot of things beside financial market stabilization.”

For that, the eurozone needs “greater strength in the economy,” he said.

Despite positive leading indicators, the eurozone is producing horrible numbers. The economy of the 17-country group is in recession, defined as two quarters in a row of negative growth. Meanwhile, unemployment, which usually rises in the wake of a downturn and only falls after the recovery is under way, hit a record high of 11.8 per cent for November. Some countries, such as bailed-out Greece, are faring even worse, stuck in a deep recession with 26.8 per cent unemployment rate. Joblessness.

Draghi told reporters following the ECB’s monthly policy-setting meeting that it was now up to governments to get their economies growing. The chief risk to the expected recovery is “slow implementation of structural reforms in the euro area.”

While governments have cut spending to control their debts, they have been slower to bring in longer-term structural reforms. Those include ending two-tier labour markets where older workers have strong protections but companies are reluctant to hire young ones because they can’t shed workers in a downturn.

The ECB president’s comments underlined a growing belief among analysts that the bank has finished cutting rates.

Joerg Kraemer, chief economist at Commerzbank, said recovery would mean the ECB might leave rates unchanged for all of this year. The rise in sentiment indicators “suggests that the recession in eurozone is likely to come to an end in spring,” he wrote in a research note. “This makes a further ECB rate cut unlikely.”

A further rate cut by the ECB would in theory encourage more economic activity by making it easier for consumers and businesses to borrow, spend and invest. But Draghi said that rates were already low enough to spur growth — and would contribute to a gradual rebound.

The decision to hold off rates and Draghi’s statement that the decision was “unanimous” caused the euro, the currency used by 17 EU countries, to rally 1 per cent to $1.3191. A currency’s value usually tracks expectations of interest rates, with lower rates often sending it lower because investors expect less return on interest-bearing investments in that currency.

The main weapon used by the ECB to ease the currency union’s crisis over too much government debt was an offer finalized in September to buy the bonds of heavily indebted countries, on condition that they tap a European financial aid program and promise to reduce their deficits. No country has asked for the help, but the mere offer has seen dramatic falls in bond market borrowing costs for Spain and Italy.

European leaders are also setting up a new system to have the ECB monitor European banks centrally. The hope is that greater controls will keep banks’ financial troubles from requiring national governments to make expensive bailouts that overwhelm public finances.

All these steps have helped calm fears that the eurozone will break up or suffer a renewed financial crisis through a government being unable to pay its debts. Now the focus has turned to economic growth, or rather the lack of it.

Analysts at Capital Economics warned that the signs of improvement so far only showed the economy shrinking more slowly — still short of recovering.

Data “will need to rise considerably further to suggest that the eurozone and, in particular, its most vulnerable economies have truly turned a corner,” they wrote.