Cautious ECB holds interest rates at 1%

Cautious ECB holds interest rates at 1%
The Financial Express, August 07, 2009, Page 18

Reuters

The European Central Bank kept interest rates on hold at a record low on Thursday as it waits to see the impact of efforts so far to revive the economy and credit flows. All 75 economists in a Reuters poll last week had expected the ECB to keep the main policy rate at 1.0% for the third month in a row. The refi rate is likely to remain at this level for at least another year, the poll showed.

“This was not surprising at all,” Nomura economist Laurent Bilke said. “They would have had very little room to cut anyway, given that the overnight market rate is around 0.35%.”

The euro was little changed after the decision. Massive supplies of ECB liquidity have pushed short-term bank-to-bank rates well below the main policy rate, and analysts said the ECB was unlikely to announce any plans to ease back on the throttle with the euro zone economy still shaky.

The ECB has cut interest rates by 325 basis points since October, but they remain the highest among the biggest developed economies.

The Bank of England, which also met on Thursday, left British rates at 0.5%.

The ECB governing council's views on economic recovery are likely to have changed little since its July policy meeting. At that time it said it expected economic activity to remain weak for the rest of the year, although the pace of decline was likely to ease from the 2.5% plunge recorded in the first quarter.

ECB president Jean-Claude Trichet was likely to stick to a similar assessment at his news conference beginning at 1230 GMT, RBS Economist Jacques Cailloux said.

“We doubt the ECB will start shifting its assessment just yet as uncertainty remains elevated and there are -- as yet -- no tangible signs that the rebound in economic indicators is sustainable,” he said.

Trichet may also outline the results of the ECB's survey of professional forecasters, due to be released next week. The main attention centers on whether the long-term inflation expectations are still seen at 1.9%.

Trichet is expected to give details on the first month of the ECB's bond programme of buying covered bonds, aimed at boosting the euro zone economy, and the market's reaction. After a slow start, the ECB has bought close to 5 billion euros in bonds backed by mortgage and public sector assets -- putting spending on track as it plans to use 60 billion over 12 months.

Dresdner Kleinwort bond analyst Ted Packmohr said the market was keen for information about spending country-by-country, the share of purchases on the primary market as opposed to the secondary market, and the maturities bought. The ECB has said it will focus on maturities of three to 10 years. “The more information they provide, the better it would be,” he said. Trichet may also offer the ECB's view on bank lending.

The ECB has repeatedly urged banks to lend on the close to half a trillion euros in one-year funds they borrowed from the ECB in late June, as a revival in bank lending is key to supporting the real economy.

Economic signals are mixed: surveys of purchasing managers suggest the recession in the services and manufacturing sectors eased in July, and economic sentiment rose to an eight-month high. But euro zone unemployment is at record levels and retail sales fell again in June, underlying the weakness in consumer demand.

Nomura's Bilke said Trichet would keep the basic scenario intact, but could accentuate signs of economic stabilisation.

“He could signal some positive signs,” Bilke said. “It's enough for him to say that short-term indicators have confirmed recession is going to be less pronounced in coming months.” But he added it was too early to update the economic outlook, especially as new ECB staff projections are due next month.

Meanwhile, inflation is likely to remain well below the ECB's benchmark of below, but close to 2% well into next year. Prices at factory gates logged their biggest annual drop on record in June and consumer prices fell for the second month running in July, by a record 0.6% annually. In June, ECB staff forecast the economy would contract about 4.6% this year and 0.3% in 2010, although positive growth is expected to return mid-year. Staff forecast inflation of about 0.3% this year and 1.0% in 2010.