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Recovery still fragile: European Central Bank

Health check of European banks will help to make monetary policy more effective

European Central Bank President Mario Draghi said he sees signs of a “dramatic” improvement in the health of the euro-area economy and that inflation will gradually return to target.

“What we have been seeing in the past three or four months is both the improvement in financial markets and that our accommodative monetary policy is finally being passed through to the real economy,” Draghi said on Friday at the World Economic Forum in Davos. “The idea is that now we have low inflation, and it will move gradually back to the objective” of just under two per cent.

Even as Draghi portrays a euro-area rebound, banks from Barclays to Commerzbank are predicting that the Frankfurt-based ECB will have to cut its benchmark interest rate in the coming months as volatility in money markets threatens to derail the recovery. Draghi, who has promised to take action to safeguard price stability if needed, also said there’s no reason to believe that current subdued price increases will turn into deflation. “One is tempted to infer that after financial crises you have a period of time with low core inflation,” he said.

“If you define deflation as a broad-based, self-feeding, persistent fall in prices, broad-based across sectors and countries — we don’t see that.”

Eurozone inflation below target: IMF DAVOS — Eurozone inflation is “way below target” and deflation is a potential risk for the bloc, International Monetary Fund Managing Director Christine Lagarde told the World Economic Forum in Davos on Saturday. In response, European Central Bank President Mario Draghii said the ECB stood ready to act if inflation went lower than forecast and reaffirmed that interest rates would remain low or go lower for an extended period of time. — Reuters

Even so, the recovery is “still weak, still fragile, still uneven,” Draghi said, adding that the risks to the outlook remain on the downside. The ECB forecasts that the euro-area economy will grow 1.1 per cent this year after an estimated contraction of 0.4 per cent in 2013. Inflation is forecast to be 1.1 per cent this year and 1.3 per cent in 2015.

Draghi said that the ECB’s upcoming health check of European banks will help to make monetary policy more effective, as interest-rate signals will be better passed through to the real economy.

Before taking over supervision of around 130 of the region’s biggest banks in November, the ECB is probing asset quality and subjecting lenders to tests of their ability to withstand financial turmoil.

Draghi said in October that he wouldn’t hesitate to fail weak banks. “The most important thing is transparency. The operation of shedding light on banks’ balance sheets should help them raise capital,” he said yesterday. “Of course banks that should go should go.”