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Mideast crisis, Ukraine events ‘threaten’ EU’s growth: Draghi ECB holds key rates steady at 0.15 pct

FRANKFURT, Aug 7, (Agencies): The Ukraine crisis has heightened risks to the euro zone’s weak and uneven economic recovery, and a tit-for-tat sanctions war could compound the problem, the European Central Bank said on Thursday as it held borrowing rates at record low levels. ECB President Mario Draghi cited instability across the Middle East as well as tensions between Russia and Western countries over the conflict in Ukraine among factors weighing on growth in the single currency area. Moscow has retaliated for European Union sanctions by halting imports of food from Europe. At a news conference after the bank’s monthly policy-setting meeting, he stressed the ECB was ready to resort to quantitative easing — printing money to buy securities — if the outlook for inflation fell further. But he brushed off July’s 0.4 percent reading, the lowest in more than four years, as a glitch due to temporary energy and food price falls.

“Geopolitical risks are heightened, are higher than they were a few months ago. And some of them, like the situation in Ukraine and Russia will have a greater impact on the euro area than they ... have on other parts of the world,” Draghi said. Having cut interest rates to record lows in June, the euro zone’s central bank kept them steady, waiting to see whether schemes such as the ultra-cheap four-year loans to banks it will launch in September will prompt them to lend more.

The decision by the ECB’s Governing Council, with representatives from the 18 countries that use the euro, had been expected by economists. Many are now shifting their attention to next year, when they hope the ECB will follow the United States and other major central banks in launching a quantitative easing programme. Draghi explicitly mentioned that option along with the possibility of buying asset-backed securities (ABS), despite the stated reluctance of Germany’s influential Bundesbank. “I can only reaffirm that the Governing Council is unanimous in its commitment to also use unconventional measures like ABS purchases, like QE, if our medium-term outlook for inflation were to change,” the ECB chief said.
 
The ECB expected strong take-up for next month’s flood of cheap money for banks to lend to businesses, he said, adding that real interest rates in the euro zone would remain negative for far longer — up to five years — than in the United States. While Thursday’s news conference did not signal any change in policy, some economists said events could make the ECB act. “The euro zone is at a crossroads and the economy can go either way,” said James Knightley, an economist with ING. “We are starting to see some signs of stagnation and the geopolitical situation is adding to the risks. Can the weaker euro and better credit conditions offset that? If they don’t, that will force the ECB’s hand.”
 
Russia has banned imports of fruit and vegetables from the European Union in retaliation for sanctions against Moscow, while NATO warned this week that Moscow could use the pretext of a humanitarian mission to invade eastern Ukraine. Nonetheless, many economists do not expect a reaction from Frankfurt unless there is a dramatic turn for the worse. “The geopolitical situation is increasing risks to the economy but we don’t expect them to change course until next year,” Societe Generale economist Anatoli Annenkov said. “We expect the ECB to launch an asset purchase programme early next year, buying private-sector rather than government bonds at the outset. But for the time being, they are going a different route to encourage lending.”
 
In June, the ECB became the first major central bank to charge banks for holding their deposits overnight, a step designed to stop them hoarding cash and lend instead. Apart from Ukraine, the euro zone faces other hurdles. Data this week showed Italy, the bloc’s third-biggest economy, has slipped back into recession while the Bundesbank says even powerhouse Germany stagnated in the second quarter. Italian Prime Minister Matteo Renzi has led calls to move away from spending austerity to adopting looser EU budget rules, but has been rebuffed by Berlin.
 
Draghi, an Italian, weighed into the debate by saying that those countries that have carried out the most convincing structural economic reforms were reaping the best rewards in higher growth — an implicit rebuke to Italy and France. He urged euro zone governments to stick to EU deficit reduction rules and not throw away the gains of fiscal consolidation. In France, the region’s second biggest economy which is also struggling, President Francois Hollande said the ECB and Germany must do more to boost growth and fight a “real deflationary risk” in Europe. Asked about mounting French calls for a weaker euro to stimulate growth, Draghi listed reasons why conditions were ripe for a fall in the euro’s exchange rate, including divergent interest rate prospects with the United States.
 
Low prices are partly a result of spending cuts and lower wages, reforms the ECB does not want to hinder. But if prices get stuck at low levels, the ECB insists it is ready to act. Speaking after the bank kept its main interest rate on hold at the record low of 0.15 percent, Draghi said the bank will “closely monitor” the possible repercussions of “geopolitical risks” on the recovery. The possibility of an escalation in Ukraine as well as a ratcheting up in tensions between the West and Russia has cast a shadow over the eurozone’s fragile upswing.
 
Draghi warned that overall risks to the eurozone’s recovery are “to the downside” and that “geopolitical developments” were one of them. Draghi said geopolitical risks are higher than they were a few months ago, and noted that “some of them — like the situation in Ukraine and Russia — will have a greater impact on the euro area than they certainly have on other parts of the world.” At first glance, Draghi said the interconnections between the eurozone and Russian economies were rather limited in terms of trade and financial flows. And in terms of major financial institutions, there were “less than a handful of names” seriously exposed.
 
However it was hard to tell how much added impact would come “once sanctions on one side and counter sanctions on the other side are going to be undertaken.” The EU and the United States imposed targeted sanctions on Russian officials and some banks and companies over what they say is Moscow’s support for armed pro-Russian separatists; Russia has responded by banning most agricultural and food imports from the West and has threatened to close its skies to overflight by airlines. Draghi said early analysis has focused on higher energy prices as a potential risk for Europe. He also mentioned fighting farther away in Iraq, Gaza, Syria and Libya as sources of risk to the eurozone.
 
As well as keeping interest rates on hold, the ECB held off from announcing other stimulus measures to boost the recovery. Draghi called the recovery “weak, fragile and uneven” and that the recent economic data suggested a “slowing down in the growth momentum.” Italy for instance has slipped into recession as its economy shrank 0.2 percent in the second quarter, its second straight quarterly decline. The ECB announced a big package of stimulus measures in June and is waiting to see how those work before doing more. That included a cut in the benchmark interest rate to a record low of 0.15 percent. That’s the rate at which the ECB loans to banks; a lower rate means banks can in theory pass that on to borrowers.
 
Draghi underlined that the bank’s 24-member governing council was ready to add new unconventional stimulus members if the economy takes a turn for the worse. That could include large-scale purchases of financial assets such as government bonds, or quantitative easing. That can drive down longer term market borrowing costs and add newly created money to the economy. Quantitative easing has been used by the United States, Britain and Japan. But the step is more complicated in a currency union of 18 countries and analysts think the ECB will keep it in reserve and use it only if the economy takes a serious turn for the worse. Analyst Howard Archer at IHS Global Insight said the ECB was in standby mode. “We still think the bar is high for large scale, full blown quantitative easing by the ECB,” he said. “But it is looking more possible that the bar could be reached if prolonged heightened geopolitical tensions cause already weak eurozone economic activity to stutter further.”

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