Sweden cuts key rate, while Bank of England stands pat
By William L. Watts, MarketWatch
FRANKFURT (MarketWatch) — The European Central Bank made no changes to interest rates Thursday, as expected, leaving the stage to Mario Draghi, who is expected to reveal details of a new bond-buying plan aimed at calming the euro-zone debt crisis.
The ECB, which sets monetary policy for the 17-nation euro zone, said its Governing Council left its key lending rate at a record low 0.75% and maintained its overnight deposit rate at 0%.
A Dow Jones Newswires survey of analysts found a minority had expected a cut in the key lending rate, while other surveys showed a split among economists.
The euro EURUSD +0.2886% traded at $1.2645, up from around $1.2617 ahead of the announcement and a gain of 0.4% from Tuesday.
Draghi’s monthly news conference is scheduled for 8:30 a.m. Eastern.
News reports point to Draghi announcing the ECB is prepared to buy government bonds with maturities of up to around three years in potentially unlimited amounts. Such moves would be the latest effort by the ECB to buy time for euro-zone policy makers by easing fears that Spain, the euro zone’s fourth-largest economy, could find itself shut out of credit markets. Spain’s fall would leave Italy, the region’s No. 3 economy and the world’s third-largest, in the cross hairs. Italy is seen as too big to bail out under the euro zone’s current rescue capacity.
The bond purchases would be “sterilized,” reports said, with the ECB draining an offsetting amount of money from the financial system through its market operations in order to prevent a potentially inflation-stoking rise in the money supply. Some economists, however, contend that deflation is a bigger threat to the struggling euro-zone economy.
By sterilizing the purchases, the ECB would avoid going down the road of formal quantitative easing, or QE, the creation of new money that is used to make asset purchases. Read Tell post on how sterilization works.
The ECB appears unlikely to impose an explicit cap on yields of troubled government bonds or on the spread between the yields of those bonds and safe-haven debt issued by Germany, economists said.
Draghi in late July vowed that the ECB would do “whatever it takes” within its mandate to preserve the euro. The ECB chief indicated the bank was ready to eliminate the “convertibility” premium, or the extra yield demanded by investors to hold certain bonds out of fear the euro could break apart. Read about Draghi and the convertibility premium.
Draghi contends the premium distorts the transmission of monetary policy by artificially boosting borrowing rates in distressed countries, putting the issue within the ECB’s narrow, price-stability mandate.
In August, he broadly outlined a plan that would see the ECB buy government bonds in the secondary market while the euro-zone rescue fund would make purchases in the primary market. A distressed country would have to first apply to the region’s rescue fund for help and agree to abide by strict policy conditions before any purchases would take place.
The euro EURUSD +0.2886% has rallied more than 4% since Draghi pledged to save the euro in July. The yield on two-year Spanish debt ES:2YR_ESP +0.66% , which hit an alarming intraday high above 7% in late July, now stands at 3.08%.
A bond-buying effort would come over the objections of Germany’s Bundesbank. Jens Weidmann, the Bundesbank president, has argued that such measures cut too close to central-bank financing of government deficits, a practice prohibited under the ECB’s charter. Weidmann last month likened bond purchases to an “addictive” drug.
If expectations for ECB action are accurate, “the lack of QE may be seen as a slight weakness but this will probably be outweighed by the unlimited nature of the potential buying,” said Gary Jenkins, director of independent credit firm Swordfish Research in London.
There is also the question of when Spain will move to request help. The government of Prime Minister Mariano Rajoy has resisted calls to apply for aid, insisting it first wants to see the details of a bond-buying plan and that it shouldn’t face new conditions on top of its already politically unpopular austerity efforts.
Beyond that, there are questions about how the ECB would enforce policy conditions if a country failed to live up to its side of the agreement.
“In the short term, the ECB (verbal) action has worked in reducing yield levels,” Jenkins said. “In the medium term, the challenge [it] face[s] is to keep politicians committed to budgetary discipline when they are in fact funding them on a seemingly unlimited basis and the fact that the economic backdrop remains challenging, to say the least.”
Bank of England holds; Sweden cuts
Earlier, the Bank of England said its Monetary Policy Committee left the key lending rate unchanged at a record low 0.5%, where it has stood since March 2009. Policy makers maintained the size of the bank’s bond-buying program, the centerpiece of its quantitative-easing strategy, unchanged at 375 billion pounds ($596.5 billion). The bank said the committee expects the asset purchases to take another two months to complete and that the “scale of the program will be kept under review.”
The British pound GBPUSD +0.0730% traded at $1.5911 versus the dollar, virtually unchanged from its level ahead of the announcement and up 0.1% from Wednesday.
Both moves were widely expected. Bank of England Gov. Mervyn King was dismissive of suggestions the bank may cut the lending rate below its all-time low at a news conference last month, while asset purchases under the recently-expanded bond-buying program won’t be completed until November.
Also Thursday, Sweden’s Riksbank cut its key lending rate by a quarter of a percentage point to 1.25%, citing expectations its economic boom will slow as the euro area’s deepening economic troubles damp exports. Read: Krona falls after Swedish central bank cuts rate .
William L. Watts is MarketWatch's European bureau chief, based in Frankfurt.
