ECB keeps main interest rate at 1pc

December 3, 2009

, FRANKFURT, Dec 3 – The European Central Bank kept its main interest rate at 1.0 percent on Thursday as markets sought signs the ECB will start unwinding exceptional economic measures introduced in the midst of the financial crisis.

The bank\’s key rate remained at the record low first reached in May when policymakers sought to spur an economic recovery, and two other reference rates, the marginal lending rate and the deposit rate, were also unchanged at 1.75 percent and 0.25 percent, a spokesman said.

Europe crawled out of recession in the third quarter with the 16-nation eurozone posting 0.4 percent growth, official European Union data confirmed earlier in the day.

Financial markets quickly focused on revised growth and inflation forecasts by ECB staff to be released during a press conference by president Jean-Claude Trichet, and on any comments regarding ECB "enhanced credit support" measures.

"The most interesting projections would be the first ones for 2011: the ECB should confirm the fragility of the current recovery by projecting both subdued GDP (gross domestic product) growth and inflation below the 2.0 percent objective, suggesting a long lasting status quo," for interest rates, Natixis economist Cedric Thellier said.

Along with other central banks around the world, the ECB flooded money markets with cheap loans to keep banks lending after the global financial system came close to meltdown late last year.

That has not happened as much as businesses and ECB governors would like however, as banks hoarded the cash to bolster their weakened balance sheets and invest in instruments like goverment bonds.

Now that global economies appear to be on the mend, markets anticipate "the first steps towards a gentle backdoor exit" from the ECB\’s accomodative monetary policy, ING senior economist Carsten Brzeski said.

ECB president Jean-Claude Trichet will probably say that a 12-month loan of central bank cash on December 16 will be the last of that length, and warn banks again not to become addicted to cheap and unlimited ECB funds.

The number of three- and six-month loans could also be diminished since they are already used less by commercial banks.

"The ECB\’s exit is about their desired gradual withdrawal from its present de facto total underwriting of the banking system via their fixed rate full allotment policy," Goldman Sachs economist Erik Nielsen said.

The Frankfurt-based ECB is also expected to issue more upbeat eurozone growth forecasts. The most recent outlook was for a contraction in GDP of 4.1 percent this year and 0.2 percent growth in 2010.

It is not all plain sailing, however, with the situation in Dubai raising fears about unlikely but not impossible debt crises in eurozone members Greece and Ireland.

"A new technical recession in the course of 2010 could not yet be ruled out. Indeed, sustainable recovery is expected for 2011, not before," Thellier said.

Despite signs that the global economy is beginning to improve, Trichet will probably avoid any hint that the main ECB interest rate will be hiked from its current record low of 1.0 percent for some time to come.

Any suggestion that rates might rise would push the euro higher on foreign exchange markets. Eurozone finance ministers see the euro as too highly priced already, Eurogroup chief Jean-Claude Juncker said Tuesday.

Policymakers worry that a strong euro could hamper economic recovery by making European exports more expensive.


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