ECB keeps rates unchanged despite stronger euro

DCM Editorial Summary: This story has been independently rewritten and summarised for DCM readers to highlight key developments relevant to the region. Original reporting by Irish Times, click this post to read the original article.

The European Central Bank (ECB) held interest rates steady for a fifth straight meeting on Thursday despite ongoing geopolitical tensions and a marked strengthening of the euro which may be cooling inflation faster than expected.

Policymakers kept the bank’s headline deposit rate unchanged at 2 per cent.

While insisting the bloc’s economy remains resilient with low unemployment and solid private sector balance sheets, they cautioned that the wider economic outlook was “still uncertain, owing particularly to ongoing global trade policy uncertainty and geopolitical tensions.”

The ECB’s decision came after data on Wednesday ⁠showed euro zone inflation fell to 1.7 per cent in January, undershooting the ECB’s 2 per cent target, as lower energy costs and a stronger euro kept a lid on consumer price rises.

The decision also comes against an increasingly volatile geopolitical backdrop with US president Donald Trump starting the year by ousting Venezuelan leader Nicolás Maduro and threatening to annex Greenland.

This has prompted a further weakening of the dollar against the euro which has the potential to damage EU exports in an already weak economy.

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There is also a risk it could pull inflation further below the 2 per cent target rate.

“The stronger euro could bring inflation down beyond current expectations,” ECB president Christine Lagarde said while noting the euro/dollar exchange rate, including the recent dollar depreciation, was discussed at the meeting.

But she said the shift remained within the average range and had been incorporated into the bank’s baseline forecasts.

Lagarde again insisted that ECB policy and inflation were in “a good place” and that euro zone inflation was gradually moving to the bank’s 2 per cent target rate.

She also welcomed the appointment of Kevin Warsh as the next head of the Federal Reserve in the US.

Markets expect the ECB to keep interest rates on hold for now, the strength of the euro muddies the waters somewhat.

“This is one of those occasions when central banks need a good sense of balance to weigh the negatives against the positives,” Deutsche Bank‘s chief European economist Mark Wall said.

“Leaving policy rates unchanged feels the right thing to do. There are external vulnerabilities, but there is also domestic resilience, helped in part by Germany’s defence and infrastructure spending,” he said.

AIB chief economist David McNamara said: “The big picture is that the ECB continues to maintain a high bar for further rate cuts in the near term, despite inflation falling below target in January to 1.7 per cent from 2 per cent in December.”

“However, that fall in inflation was almost entirely due to lower energy prices, which could unwind later in the year,” he said.

Separately the Bank of England kept interest rates on hold on Thursday, but only after an unexpectedly narrow 5-4 vote, and ​it said it expected a future cut if a sharp fall in inflation due in the coming months proved not to be a blip.

Despite a big cut to its economic growth forecast this year and a rise in unemployment, the UK’s central bank left its benchmark rate at 3.75 per cent, as expected.