European Central Bank edges closer towards tighter monetary policy as it removes reference to lower interest rates

Jasper Jolly
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Mario Draghi has faced pressure to tighten monetary policy (Source: Getty)

The European Central Bank (ECB) this afternoon removed a reference to cutting interest rates further in its latest monetary policy decision, a vital sign it is acknowledging the improving European economy in an attempt to placate critics of its ultra-loose monetary policy.

In a statement announcing its latest monetary policy, the ECB said it expects "the key ECB interest rates to remain at their present levels for an extended period of time".

That discounted the possibility of "lower" interest rates mentioned in previous forward guidance, but the central bank also repeated its insistence that interest rate hikes will only come "well past" the end of its quantitative easing programme.

Read more: Softer data complicates European Central Bank guidance debate

At a press conference in Tallinn, Estonia, ECB president Mario Draghi said: "The risks to the growth outlook are now broadly balanced," after previously saying they were tilted to the downside.

The ECB held its key interest rates steady, including its main refinancing operations rate at zero per cent. It also left quantitative easing untouched, disappointing some investors who wanted the central bank to mention changing to its asset purchase programme.

Draghi said moves to start tapering the €60bn (£52bn) monthly asset purchases were not discussed, but repeated the ECB's view that the end of quantitative easing will not come until inflation rises sustainably to its two per cent target.

However, that prospect seemed more distant as the ECB's economists revised down their forecasts for inflation. Consumer prices are expected to grow by only 1.3 per cent next year, down from a 1.6 per cent prediction in March. Draghi attempted to downplay the downgrade, insisting changes were down to fluctuations in food and energy prices.

Shilen Shah, bond strategist at Investec, said: "Eurozone monetary policy looks like it is likely to change only very slowly, with 'subdued' core inflation pressures continuing to be a concern for the ECB."

The tweak to monetary policy language comes as the European economy pulls further away from the risk of deflation. The European Commission today announced the Eurozone economy grew faster than previously thought, with output expanding by 0.6 per cent in the first quarter, a 1.9 per cent annual rate. Unemployment has also improved steadily.

Read more: Eurozone unemployment falls to lowest in eight years (but inflation slows)

However, inflation has remained stubbornly low, returning to 1.4 per cent in May after hitting 1.9 per cent in the previous month. Core inflation, which strips out the effects of volatile food and fuel prices, fell to only 0.9 per cent in May.

Draghi has repeatedly insisted the central bank will not consider tightening monetary policy until inflation rises sustainably, without the effects of the more volatile components, towards its two per cent target.

The euro dipped against the US dollar as Draghi spoke, trading briefly below $1.12 before recovering to around $1.122 at the time of writing. It had earlier traded above $1.126 in morning trading.

How to understand the European Central Bank's interest ratesĀ 

The European Central Bank (ECB) has three rates:

  • The main refinancing operations: what banks pay to borrow from the ECB

  • The rate on the marginal lending facility: the rate at which banks lend to each other overnight

  • The deposit facility: the rate banks receive to leave money with the ECB overnight

The ECB has kept interest rates unchanged since March 2016, when all three were cut. They have since stayed at zero per cent, 0.25 cent and minus 0.40 per cent respectively.

If a rate is negative the bank will pay the ECB (rather than receiving money in interest). Negative rates are intended to encourage banks to lend money to businesses rather than holding it themselves or, as is the case with the deposit facility rate, depositing it with the ECB overnight.

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