Europe's Central Banks Remain Cautious on Economic Recovery

By Todd BuellFeaturesDow Jones Newswires

Central banks in Europe are expected to show continued caution about the region's economic recovery on Thursday, signaling that they are in no rush to follow the Federal Reserve in steadily raising interest rates despite a rare synchronized expansion across the world economy.

The European Central Bank is expected to leave its policy mix unchanged and signal it won't raise interest rates soon, even as its new economic projections forecast strong growth for the 19-nation eurozone through 2020.

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The Swiss National Bank on Thursday kept its deposit rate at minus 0.75% and said it was still willing to intervene in currency markets if the Swiss franc gets too strong.

The decision, which was expected by economists, came as Switzerland has started to see some benefit from the recent weakening of the franc, particularly versus the euro.

Because much of Switzerland's exports are destined for the eurozone, the SNB's monetary policy is heavily dependent on what the ECB does. Although the ECB is scaling back its quantitative easing program, it isn't expected to begin raising interest rates for the foreseeable future.

"We only expect the first SNB interest rate increase when the ECB has started to raise rates," said analysts at Commerzbank.

The euro has strengthened over 6% against the franc since the middle of the year, potentially boosting Swiss exports to the eurozone while also raising prices of imported products.

"The overvaluation has thus continued to decrease, yet the franc remains highly valued," the SNB said. "A renewed appreciation would still be a threat to price and economic developments."

The decisions by European central banks are likely to underline a persistent policy divergence between the world's major central banks a decade after the onset of the global financial crisis. While the Fed has been gradually nudging up interest rates for the past two years, the ECB isn't expected to start raising rates until late 2019.

That divergence helps to support a European economic recovery that is at an earlier stage than that in the U.S.--not least by holding down European currencies against the dollar and supporting the region's exports. ECB officials are eager to keep their options open amid ongoing economic risks: While the U.S. economy is expected to receive a boost next year from planned corporate-tax cuts, European policy makers are navigating major elections and Britain's possibly messy departure from the European Union.

The Fed voted Wednesday to raise short-term interest rates for the third time this year, and signaled it would stay on a similar path next year amid a leadership transition. Hours after the Fed's move, the People's Bank of China followed suit, increasing the rates it charges in open-market operations and on its medium-term lending facility.

On both sides of the Atlantic, policy makers are wrestling with weak inflation, which has yet to rebound strongly despite strengthening economic growth and employment.

Recent data suggest the eurozone's economic recovery continues to strengthen and is reassuringly broad.

A survey of 5,000 manufacturers and service providers released Thursday suggests the eurozone economy ended the year on a strong note, as the composite Purchasing Managers Index rose to 58.0 in December from 57.5 in November to reach its highest level in almost seven years. The acceleration in activity was led by eurozone factories, which had their strongest month since records began in 1997.

"The eurozone economy is picking up further momentum as the year comes to a close," said Chris Williamson, chief business economist at IHS Markit, the data firm that compiles the surveys.

Europe's caution raises concerns that lingering central-bank stimulus policies could fuel encourage excessive risk-taking by investors or the misallocation of capital to weak firms.

Lena Komileva, chief economist at G+ Economics in London, warns of a "growing risk that this cycle will end in another financial event unless central banks get ahead of the curve."

In a report published last month, the ECB said it sees the potential for large corrections in global asset prices as investors load up on risky investments even as major central banks dial down their postcrisis stimulus policies.

"By reducing interest rates for all firms, [central banks] may indirectly permit inefficient firms to remain in business--becoming so-called zombie firms," Yves Mersch, who sits on the ECB's six-member executive board, said in a speech in Frankfurt last week.

Brian Blackstone in Zurich and Paul Hannon in London contributed to this article.

Write to Todd Buell at todd.buell@wsj.com

(END) Dow Jones Newswires

December 14, 2017 04:46 ET (09:46 GMT)