Investors look to ECB for guidance as economy perks up

(Reuters) -

Signs of a tentative euro zone recovery are easing pressure on the European Central Bank to take new policy action and on Thursday it will emphasize its message that interest rates will stay at record lows for an extended period.
Stronger economic reports in the past few days support the ECB's expectations of a recovery later this year, though the policy options are complicated by market responses to the U.S. Federal Reserve's plans to slow its economic stimulus program.

The ECB reacted last month to market turmoil sparked by the Fed's exit plan by breaking with precedent and declaring it would keep interest rates at record lows for an extended period and that it may yet cut further.

Individual policymakers' interpretation of the ECB's forward guidance over the last month has blurred the message, however, with Bundesbank chief Jens Weidmann insisting the ECB had not "tied itself to the mast".

The result is that the initiative has proven only partially successful in calming markets and offsetting fallout from the Fed's stance.

"In some respects there is some additional complexity this month," said Nomura economist Nick Matthews, who expected the ECB to leave its main rate on hold at a record low of 0.5 percent, though he saw a risk of a cut.

"You've got the improvement in the survey data but at the same time you've got a month's worth of forward guidance impact to look at, and the bottom line is it has not made a huge impact on the level of market rates," he added.

On Wednesday, the Fed said it would keep buying $85 billion in mortgage and Treasury securities per month in an effort to strengthen the economy, and gave a more dovish tilt to its post-meeting statement.

The Fed downgraded its view of the U.S. recovery, calling the pace of growth "modest" rather than "moderate," as it had consistently done for most of the past year. Euro zone government bonds rallied in response.

In the euro zone, unemployment fell for the first time in more than two years in June, business and economic sentiment rose to a 15-month high in July, and surveys suggested unexpected growth in private sector business.

A Reuters poll showed 69 of 70 economists expect the ECB to refrain from rate cuts on Thursday.
But lending to firms is still declining in the euro zone and is especially weak across the bloc's troubled debtor countries, which could keep calls for lower policy rates alive.

ECB President Mario Draghi said the 23-man Governing Council discussed a rate cut last month, before deciding to hold.

"I think they're going to have a discussion about cutting rates again, there will be some on the Governing Council who will have arguments for that - to push a recovery, to really get things going," said Berenberg Bank economist Christian Schulz.

"But net-net, everything that happened between last month's meeting and this month was positive and in some cases may have even surprised the ECB on the upside, so I don't really see them cutting rates," he added.

GUIDANCE ON GUIDANCE

New ECB staff forecasts in September may give ECB policymakers grounds to cut rates or - if the growth projections are revised up - make their language less dovish.

In addition to the growth outlook, the focus at Thursday's post-rate decision news conference will be on discussion at the ECB about publishing the minutes of Council meetings, and the forward guidance message.

Draghi said on Tuesday he wants to begin publishing the minutes of ECB Council meetings, which until now have been kept secret, and Bundesbank President Jens Weidmann also favors the move.
However, such a move to increase transparency at the central bank is sure to meet resistance from some ECB policymakers, who fear the move could open them up to political pressure from national governments, and a change would take time to agree.

Explaining the ECB's expectation that it would keep rates at record lows for an "extended period", Draghi gave little away last month when pressed on the timeframe, saying it was "not six months, it's not 12 months. It's an extended period of time."

He cited a tame inflation outlook, economic weakness and subdued monetary dynamics as underpinning this expectation.

But the ECB's steer is more flimsy than the guidance offered by the Fed, which, aside from getting ready to call time on its quantitative easing plan, has promised to keep its main interest rate near zero at least until the unemployment rate falls to 6.5 percent and as long as inflation stays below 2.5 percent.

Analysts did not expect Draghi to come out with any specific time horizon or thresholds for the ECB's guidance on Thursday, making the tone of his comments all the more important.

"He will try to verbally reinforce the guidance and the downside bias on rates, and probably threaten action if there is no improvement, which could put the focus on the next couple of meetings for any additional policy measures," said Matthews at Nomura.
(Editing by Stephen Nisbet)