Draghi signals ECB officials watching rising market rates

By Paul Gordon

ECB President Mario Draghi

European Central Bank President Mario Draghi signaled that officials are watching rising money market rates, which are threatening his drive to reassure investors that borrowing costs will stay low.

“We will remain particularly attentive to the implications that these developments may have to the stance of monetary policy,” Draghi said at his monthly press conference in Frankfurt today after the ECB left its benchmark rate at a record low of 0.5 percent. “I’m very, very cautious about the recovery. The shoots are still very green.”

Draghi is trying to convince markets that he will keep interest rates low for an extended period to support the euro area’s recovery from its longest-ever recession. Rate expectations have risen close to levels that he described last month as “unwarranted,” suggesting some investors are questioning his promise.

The overnight rate that banks expect to charge each other by the ECB’s August 2014 meeting, as measured by Eonia forward contracts, was at 0.31 percent at 3:15 p.m. in Frankfurt. That’s near the level that triggered Draghi’s promise on July 4 to keep rates low for an extended period. The rate fell to 0.09 percent by July 8.

Bank Repayments

The euro fell after Draghi’s remarks, declining to $1.3146 from around $1.32 when the press conference spoke.

Draghi said that liquidity in money markets is tightening as banks repay loans taken out at the depths of the euro crisis, reducing “excess liquidity.”

“Repayments of funds taken up in the context of the three- year longer-term refinancing operations reflect improvements in financial market confidence, some reduction in financial market fragmentation and the ongoing deleveraging by euro area banks,” he said.

Draghi also said that the economy will recover “at a slow pace” and reiterated the ECB’s position that policy will “remain accommodative for as long as necessary.”

The ECB today raised its forecasts for the euro area’s economic growth. Gross domestic product will shrink by 0.4 percent this year compared with a previous forecast of 0.6 percent and rise by 1 percent in 2014. Inflation will be 1.5 percent this year, versus a prior projection of 1.4 percent. Next year’s estimate was unchanged at 1.3 percent.

“Risks continue to remain to the downside,” Draghi said.

The Bank of England kept its bond-purchase target at 375 billion pounds ($587 billion) today and maintained its key rate at 0.5 percent. Sweden’s Riksbank left its key repo rate unchanged at 1 percent for a fourth consecutive meeting.

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