Europe's Central Banks Remain Cautious on Economic Recovery--4th Update

By Tom Fairless in Frankfurt and Jason Douglas in LondonFeaturesDow Jones Newswires

Central banks in Europe showed 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 left its interest rates unchanged, even as its new economic projections forecast strong growth for the 19-nation eurozone through 2020.

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"The incoming information indicates a strong pace of economic expansion and a significant improvement in the growth outlook," said Mario Draghi, the ECB's president, in a news conference.

The ECB's economists now expect the eurozone's economy will grow by 2.3% in 2018, a big increase from the 1.8% growth projected as recently as September. They continue to expect this year to be the currency area's best since 2007.

However, Mr. Draghi said interest rates would "remain at their present levels for an extended period of time" and confirmed the ECB's plan to continue buying government bonds and other assets until September 2018, but at the reduced monthly rate of EUR30 billion ($35.5 billion).

The reason for its continued caution is that the pickup in growth has yet to significantly change the outlook for inflation. The ECB's economists raised their inflation forecast for next year, but still see it staying below the target of just under 2% in both 2018 and 2019.

Like the ECB, the central banks of Switzerland and Norway left their key interest rates unchanged, and indicated that a first move to lift them back to levels that were considered normal before the global financial crisis is some way off.

Because much of Switzerland's exports are destined for the eurozone, the SNB's monetary policy is heavily dependent on what the ECB does.

"To be very clear, it's too early to talk about normalization in the case of the Swiss National Bank," said Thomas Jordan, who heads the institution.

But there are signs that some of Europe's central banks are contemplating an earlier start to normalization than previously indicated. Norway's central bank said it now expects a first rate increase in the autumn of 2018, having previously expected to move in 2019.

The Bank of England also left its benchmark interest rate unchanged, although it is ahead of most of its European peers, having last month raised borrowing costs in the U.K. for the first time in a decade.

That is because it faces a unique challenge. Officials fret the country's planned withdrawal from the European Union in early 2019 is holding back investment, and squeezing the economy's capacity to produce goods and services.

The BOE's Monetary Policy Committee said in a statement that it expects to further increase its benchmark rate over the next three years to bring annual inflation, which hit 3.1% in November, back to its 2% target. Future rate rises are expected to be gradual and limited, it said.

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 eurozone factories had their strongest month since the measure 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.

Brian Blackstone in Zurich, Dominic Chopping in Stockholm and Paul Hannon in London contributed to this article.

Write to Tom Fairless at tom.fairless@wsj.com and Jason Douglas at jason.douglas@wsj.com

(END) Dow Jones Newswires

December 14, 2017 09:12 ET (14:12 GMT)