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European Central Bank holds interest rates as Draghi warns of downside risks

Key Points
  • The ECB has been forced to backtrack its plans to tighten monetary policy in recent weeks, amid an intensifying climate of economic gloom.
  • Interest rates on its marginal lending facility and deposit facility will remain unchanged at 0%, 0.25% and -0.40%, respectively.
  • The euro stood little changed at $1.1259 at around 2:00 p.m. London time.
VIDEO5:1405:14
ECB's Draghi: Euro zone risks remain tilted to the downside

The European Central Bank (ECB) held interest rates steady on Wednesday, shortly after the International Monetary Fund (IMF) sharply downgraded its economic growth forecast for the euro zone economy.

The ECB has been forced to backtrack on its plans to tighten monetary policy, amid an intensifying climate of economic gloom.

Speaking at a press conference in Frankfurt, Germany on Wednesday, ECB President Mario Draghi warned that data gathered by policymakers in recent weeks had confirmed "slower growth momentum" in the euro zone.

Economic uncertainty relating to geopolitics, protectionism and emerging markets had negatively impacted investor sentiment in the bloc, he added, with risks "tilted toward the downside" over the coming months.

The German 10-year government bond yield, an important benchmark for European fixed-income assets and one that is viewed as a safe haven for investors, dipped into negative territory on the back of Draghi's comments. The euro also hit session lows against the dollar, down 0.3%, to trade at $1.1232.

Interest rates on its marginal lending facility and deposit facility will remain unchanged at 0%, 0.25% and -0.40%, respectively. These have been at record lows following the euro sovereign debt crisis of 2011 in an effort to boost inflation and stimulate growth.

VIDEO2:0702:07
ECB holds interest rates steady amid slowdown concerns

The euro zone's central bank, for those nations that share the single currency, ended its massive bond-buying program back in December. But, a rapid decline in sentiment and weak demand from abroad has ratcheted up the pressure for policymakers to unveil even more stimulus.

Two-tiered system

Draghi cautiously addressed market speculation about further delays to the central bank's first post-crisis rate hike and the side effects of years of negative rates on Wednesday.

Meeting earlier than usual so top policymakers can attend the IMF's Spring Meeting in Washington, D.C., this week, investors were anxious to understand more about the so-called two-tiered system for bank reserves.

European Central Bank President Mario Draghi arrives for the European Council Summit in Brussels, Belgium, on March 22, 2019.
JULIEN WARNAND | AFP | Getty Images

Draghi had previously said the ECB must decide whether it needs to mitigate the side-effects of negative rates but insisted on Wednesday that it was too early to decide on a two-tiered system.

This measure aims to protect banks from part of the cost incurred by negative rates — akin to moves taken by central banks in Switzerland and Japan.

The approach would mean that banks are exempted in part from paying the ECB's -0.40% annual charge on their excess reserves. That would boost the banks' profits at a time when many lenders struggle with low profitability.

Some members of the ECB's Governing Council are said to be in favor of such a move.

However, forthcoming personnel changes at the ECB could risk delaying a discussion about a two-tiered system and the likelihood of an interest rate hike over the coming months.

Alongside ECB Chief Economist Peter Praet, Draghi is scheduled to step down in October and policymakers are thought to be reluctant to negotiate a fundamental revamp of monetary policy before new leaders take charge.

The stars of the European Union sit on banners flying outside the European Central Bank headquarters in Frankfurt, Germany, on July 20, 2017.
Krisztian Bocsi | Bloomberg | Getty Images

Alexis Gray, senior economist at Vanguard Asset Services, told CNBC Wednesday that the ECB was probably "somewhat hamstrung" when it comes to ramping up stimulus measures over the coming months.

On Tuesday, the IMF slashed its forecast for global economic growth this year, saying a slowdown could force world leaders to coordinate stimulus measures.

The IMF also sharply downgraded growth in the euro zone. It now expects the bloc to grow at 1.3% in 2019 — lower than its forecast had been six months ago.

TLTROs

One example of stimulus introduced by the central bank last month was a series of quarterly targeted longer-term refinancing operations (TLTRO-III). The program, which is designed to stimulate bank lending in the euro zone, is set to start in September 2019 and end in March 2021.

However, Draghi warned that the pricing of TLTRO will take into account a "thorough assessment of the bank-based transmission channel of monetary policy as well as further developments in the economic outlook." He also added that any information on TLTROs will be communicated at forthcoming meetings.

The TLTROs are loans that the ECB provides at cheap rates to banks in the euro area. As a result, lenders are able to provide better credit conditions to customers, which in turn stimulates the real economy.

This mechanism was first introduced in 2014, before being brought in for a second time in March 2016.

— CNBC's Silvia Amaro contributed to this report.