Insight: ECB drops old philosophy but is short of new options

Mon Jul 8, 2013 6:09am EDT
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By Paul Carrel

FRANKFURT (Reuters) - The European Central Bank's vow last week to keep record-low interest rates "at present or lower levels for an extended period" is a big philosophical shift for a bank that used to insist it would not tie its hands.

On the face of it an unprecedented and bold move, such 'forward guidance' is really just formal recognition of what markets expected anyway, and the bank's realistic policy options are narrowly confined.

ECB President Mario Draghi, who vowed a year ago to do "whatever it takes" to save the euro, said the move was driven by market volatility, which set in after the U.S. Federal Reserve last month set out a plan to begin slowing its stimulus.

"Draghi's message was a clear break from the 'we never pre-commit' ECB of the past," said Andrew Bosomworth, a senior portfolio manager at Pimco, the world's largest bond fund.

"The Governing Council wants the world to know they are on a different timetable to the Fed," he added.

But the ECB's steer is more flimsy than the guidance offered by the Federal Reserve or even the Bank of England, which suggested last Thursday it could give more detailed guidance on monetary policy as soon as next month.

The risk is that when the Fed does begin unwinding its stimulus, the ECB's words won't be enough to protect the euro zone from the fallout, and market interest rates will rise - a scenario that would make the bloc's escape from crisis harder.

Then the ECB would have to back up its words with action, and the policy options it has are unpalatable to many at the bank - a conservative institution focused on inflation fighting.   Continued...

European Central Bank (ECB) President Mario Draghi (R) and Vice President Vitor Constancio address the monthly ECB news conference in Frankfurt July 4, 2013.REUTERS/Ralph Orlowski