ECB's Draghi gives market flavor of optimism | Reuters

By Francesco Canepa and Balazs Koranyi
| FRANKFURT

FRANKFURT The European Central Bank pledged on Thursday to keep its aggressive stimulus policy in place at least until the end of the year but signaled a diminishing urgency for more policy action, enough to send the euro and bond yields higher.ECB President Mario Draghi said the Bank had removed one phrase from his standard introductory statement that pledged it would act "using all the instruments available within its mandate" if needed to achieve its objectives, highlighting an improvement in the outlook."That's been removed, basically to signal that there is no longer that sense of urgency in taking further actions ... that was prompted by the risks of deflation. That was the assessment of the Governing Council," Draghi told a news conference.In another small concession to conservatives, the ECB also allowed a cheap borrowing scheme for banks to expire, though it kept open the possibility of reviving it.Although the tweaks are essentially the smallest possible changes, that was enough to send the euro EUR= up half a percent and bank shares .SX7E 2.2 percent higher, as expectations firmed that the next move will indeed be a tightening of policy, possibly later this year.The ECB has faced calls from Germany, Europe's largest economy, to start winding down its 2.3 trillion euro ($2.43 trillion) bond-buying scheme, or at least signal its intention to do so, as growth and inflation rebound.STIMULUS STILL NEEDED
Still, Draghi maintained a pledge that rates could go even lower if needed, warning that very substantial stimulus was still needed as underlying inflation is weak and growth risks remain tilted to the downside. "If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the program in terms of size and/or duration," the ECB said in a statement.

Justifying his stance, Draghi presented upgrades in inflation expectations for this year and next but argued they did not alter the overall picture."There is no sign yet of a convincing upward trend on underlying inflation," he told reporters, adding that inflation -- which hit the ECB's near 2 percent target last month -- was expected to rise "only gradually" in the medium term.The ECB now sees headline inflation of 1.7 percent this year compared to an earlier estimate of 1.3 percent, and 1.6 percent next year compared to a previous 1.5 percent estimate. It saw prices rising an unchanged 1.7 percent in 2019."Draghi is erecting barriers to higher interest rates, and not without reason," Commerzbank economist Joerg Kraemer said. "Eurosceptic parties are on the advance in a number of countries," he added.

The ECB is scheduled to cut the pace of its bond purchases by a quarter from next month but continue them at least until year-end, or longer if it thinks inflation is below target.ECONOMY IMPROVING
But nearly a decade after the 19-member currency bloc's woes began, its economy is looking in better shape.Economic sentiment is at a six-year high, trade is rebounding, services and manufacturing output is rising, and unemployment is at its lowest since 2009. Draghi accordingly announced small upgrades to euro zone growth forecasts, now seen at 1.8 percent this year and 1.7 percent next.Germany's central bank governor Jens Weidmann and ECB director Yves Mersch have both made the case for ruling out further rate cuts.

German Finance Minister Wolfgang Schaeuble went further on Thursday, saying he was in favor of a "timely start to the exit" from the ECB's loose monetary policy, echoing calls from the German banking association and the Ifo economic institute. That has left Draghi walking a tightrope, as improvements on the economic front are at risk of being derailed by hazards including the Dutch and French elections and global economic governance under new U.S. President Donald Trump.Economists in a Reuters poll said the ECB's next move would be either a tweak of its guidance in the second half of this year or a gradual reduction in its asset-buying next year."In our view, the main message is that the ECB is feeling better about the outlook and therefore inching towards an eventual exit, without being in a huge rush right now," JPMorgan economist Greg Fuzesi said.Among the political risks on the horizon, the French election is likely to be of particular concern. With far-right candidate Marine Le Pen wanting to take France out of the euro zone, markets are already bracing for a shock.The cost of insuring French government debt against default has doubled since the start of the year FRGV5YUSAC=MG while the yield differential between five-year French and safe-haven German bonds rose to its highest since 2013 last month.Investor nerves are affecting debt of periphery countries such as Italy and Portugal even though the ECB's main indicator of stress in the financial system is trending downwards.Asked about the possibility that the bloc might break apart, Draghi said on Thursday: "Frankly I don't see that. There are tensions but not anything that is that serious. In any event ... we are ready. The euro is irrevocable." (Additional reporting by Andreas Framke; Writing by Mark John; Editing by Catherine Evans and Gareth Jones)

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Published Date: Mar 09, 2017 11:30 pm | Updated Date: Mar 09, 2017 11:30 pm


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