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Draghi says ECB ready to act, but unsure how

Sakari Suoninen and Eva Taylor
Mario Draghi, President of the European Central Bank (ECB) answers reporter's questions during his monthly news conference at the ECB headquarters in Frankfurt, December 5, 2013. The ECB announced that interest rates will be unchanged. REUTERS/Kai Pfaffenbach

By Sakari Suoninen and Eva Taylor

FRANKFURT (Reuters) - The European Central Bank is ready to take fresh policy action to support the euro zone economy but has not yet worked out a detailed plan of which policy tool to use when, the bank's president said on Thursday.

After its final policy meeting of 2013, Mario Draghi also said the ECB will only offer banks a fresh batch of long-term loans if it is confident they will lend on the funds, putting a question mark over the tool markets expect the ECB to use next.

The ECB left its key interest rate at 0.25 percent, choosing not to follow through on November's surprise cut. Markets expect further action in 2014, something Draghi did nothing to deflect.

"We may experience a prolonged period of low inflation to be followed by a gradual upward movement ... later on," he told a news conference. "We are monitoring developments closely and are ready to consider all available instruments."

In the run-up to Thursday's meeting, several policymakers flagged the ECB's readiness to ease policy further, if needed, with unconventional instruments, such as asset purchases - known as quantitative easing (QE) - or a negative deposit rate.

Draghi reiterated the bank's readiness to act if necessary but gave no indication it was about to use such policy tools.

"The level of preparedness is pretty high on all (policy options)," he said, before later adding: "Which instruments would we deploy against which contingency? We haven't really done any reflection on that."

Draghi's comments left analysts feeling the ECB did not have a precise game plan on which of the so-called non-standard policy tools it would use under which circumstances.

"We did not get the impression that the ECB already has a detailed plan of action ready," said ING's Carsten Brzeski.

But with ECB interest rates already at a record low, financial markets are looking to the bank to issue a new round of LTRO loans to help support the battered euro zone economy, where inflation is running well below target.

The ECB injected over 1 trillion euros (832.97 billion pounds) into the financial system with twin LTROs in late 2011 and early 2012 in response to a funding crunch.


Draghi said banks' liquidity positions had improved since the last batch of LTROs, and attached conditions to any repeat.

"If we are to do an operation similar to the LTRO, we're going to make sure this is being used for the economy," Draghi told his monthly news conference after the ECB left rates unchanged at a record low of 0.25 percent.

"And we'll make sure this operation is not going to be used for subsidising capital formation by the banking system in these carry trade operations," he added.

Banks invested much of the previous round of cheap money in stocks and bonds and made a tidy profit. At the same time, lending levels have continued to fall.

A Reuters poll of economists last week showed they expected the ECB to offer banks another wave of cheap cash early next year through long-term loans. [ID:nL5N0JC36T] Many still expect such a ploy, even if it has strings attached.

"It seems highly possible that any future LTRO would be tailored specifically towards bank lending," said Howard Archer at HIS Global Insight.

Such a targeted lending operation would be harder to design. Britain's Funding for Lending Scheme (FLS) has met with mixed success. Britain's central bank also left policy on hold on Thursday.

Draghi said Thursday's discussion had not focused on any one measure but a "brief discussion" was held about cutting below zero the deposit rate it pays banks for holding their money overnight - an attempt to get them to lend more.

The decision to hold the main refinancing rate at a record low was widely expected after inflation edged up to 0.9 percent in November, partly reversing a plunge to 0.7 the month before. Unemployment has also fallen slightly.

Fresh forecasts from ECB staff predicted inflation would average just 1.1 percent next year and 1.3 percent in 2015 - well below the ECB's target of close to but below 2 percent.

Growth is seen at a sluggish 1.1 percent next year. Draghi said the risks to that outlook were skewed to the downside.

Asked after Thursday's meeting what was next on the ECB policy front, one ECB policymaker, who requested anonymity, said: "It's going to be quiet a little bit, we're going to look into (options), we have to be ready just in case it gets worse."

(Writing by Mike Peacock. Editing by Jeremy Gaunt, Larry King)