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ECB to sit tight ahead of high-risk elections

March 09,2017 12:28

FRANKFURT The European Central Bank is set to keep monetary policy firmly on hold on Thursday as it casts a nervous eye towards high-risk elections in France and the Netherlands during an upsurge in populist sentiment that threatens to derail the ...and more »

By Francesco Canepa and Balazs Koranyi

FRANKFURT The European Central Bank pledged on Thursday to keep its aggressive stimulus policy at least until the end of the year, but markets leapt higher as it signaled there was less of a need to prop up growth and inflation in the euro zone.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."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.That was enough to send German 10-year bond yields up 5 basis points to hit a one-month high of 0.43 percent DE10YT=TWEB, while the euro rose to the day's high at $1.0605 EUR=, up more than half a percent on the day. European shares hit session highs, erasing earlier losses. The ECB's leadership has faced calls from Germany 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. The Frankfurt-based central bank nonetheless stuck to its plan of continuing the purchases until December. It also pledged to keep interest rates at current, record-low levels until long after that, or even cut them if necessary. "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.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.

But nearly a decade after the 19-country 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 will be either a tweak of its guidance in the second half of this year or a gradual reduction in its asset-buying next year.Among political risks on the horizon, the French election is likely to be a 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." (Writing by Mark John; Editing by Catherine Evans)

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