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Draghi Signals Economy Must Worsen for ECB to Cut Rates

Draghi Signals Economy Must Worsen for ECB to Cut Rates

Mario Draghi signalled that Europe’s stuttering economy will have to get worse before he’ll consider cutting interest rates. Even as the European Central Bank President yesterday admitted that recent economic data in the euro area has been “disappointing,” he insisted that a recovery will appear later this year. While Draghi acknowledged the Governing Council considered a rate cut, yesterday marks the third time in a row the Frankfurt-based ECB has revised its growth outlook downward without adjusting policy. At the same time, lending conditions for businesses in crisis- hit nations such as Spain and Italy haven’t improved, and the turmoil unleashed by last month’s Italian election illustrates that the route out of recession could be bumpy. He also played down disruptions to what the central bank calls the “transmission mechanism,” by which its official interest rates should influence the cost of borrowing for companies and households.

Meanwhile, Bank of England policy makers who voted to hold fire on stimulus yesterday will have more legitimacy to act in a month if Chancellor of the Exchequer George Osborne changes their remit and clears the path for more loosening Currently, the MPC’s job is restricted to targeting 2% inflation. And while a weaker pound benefits manufacturers by boosting export competitiveness, it also fuels domestic inflation by raising import costs. Prime Minister David Cameron yesterday rejected suggestions that cutting taxes or increasing government spending would help the struggling economy, saying the risk of higher interest rates is too great. He also called on the central bank to aid growth.

On the FX Markets, even though GBP/USD reversed earlier weakness after the BoE refrained from boosting the APF program, the underlying momentum remains bearish. Technical support levels are seen at 1.4949 which is the July 2010 low and then at 1.4687 which is the June 2010 low. The FT reported that options include giving the MPC greater time to bring inflation back to the 2% target, giving the BoE a Fed-style dual mandate, and targeting cash spending in the economy rather than inflation.

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