ECB: Interest Rates on Hold Until End of 2010

July 7th, 2009

The European Central Bank will keep interest rates at a record low for more than a year and may yet need to expand its use of unconventional tools as it battles the worst recession since World War II, economists said.

ECB officials meeting in Luxembourg will leave the benchmark rate at a record low of 1 percent, according to all but two of 60 economists in a Bloomberg News survey. The central bank, led by President Jean-Claude Trichet, may keep the rate there until the fourth quarter of 2010, a separate survey shows.

The ECB last week lent banks a record 442 billion euros ($621 billion) for 12 months at its key rate in the hope they will pass on cheaper credit to companies and households. It will also start buying 60 billion euros of covered bonds this month to encourage lending. Trichet may today unveil further details of the plan, which was a compromise after policy makers failed to agree on a package twice that size.

“The ECB is pretty much done with cutting rates,” said Guillaume Menuet, an economist at Bank of America-Merrill Lynch in London. “However, they are very concerned about credit developments. If there is no improvement by October, the debate about expanding the asset purchases will resurface.”

The ECB, which holds Governing Council meetings twice a year away from its Frankfurt headquarters, announces its rate decision at 1:45 p.m. and Trichet holds a press conference 45 minutes later.

The central bank for the 16-member euro region has been reticent to follow the examples of the U.S. Federal Reserve, Bank of England and Bank of Japan, which have lowered their main rates to close to zero and are buying government and corporate bonds to reflate their economies.

The ECB, whose key rate is still the highest among the Group of Seven nations, has focused instead on getting credit flowing through the banking system again, arguing that two thirds of its economy is financed by banks.

Even so, loans to households and companies in the euro area grew at the slowest pace on record in May as the recession crimped demand for debt and prompted banks to tighten credit standards.

While the ECB’s measures have stabilized the banking sector, “they have not, at this stage, succeeded in pushing credit into the real economy,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London. That could be achieved by buying corporate bonds, he said.

The ECB initially considered a package of asset purchases worth 125 billion euros that included corporate bonds and commercial paper, according to people briefed on the talks. Germany’s Axel Weber opposed buying assets of any sort. Other ECB officials, such as Athanasios Orphanides from Cyprus, have said more may need to be done to temper the risk of deflation.

Consumer prices fell 0.1 percent in June from a year earlier. That’s the lowest inflation rate Europe has seen since 1953, according to Royal Bank of Scotland. The ECB predicts the euro-region economy will contract about 4.6 percent this year.

“The primary goal should be to restore economic growth as fast as possible,” ECB council member Ewald Nowotny said at a conference on June 16. “It is necessary to use all possible means to secure a recovery,” he said in a June 19 interview, adding he expects interest rates to stay on hold into 2010.

Some policy makers are more worried that the stimulus being provided by central banks and governments will sow the seeds of future inflation. Deflation risks “are extremely limited,” ECB Executive Board member Juergen Stark said June 25. The bank will “swiftly” withdraw additional liquidity when the economy improves, he said.

There are signs that the worst of the recession may be over. The contraction in Europe’s services and manufacturing industries is slowing and confidence in the economic outlook rose to a seven-month high in June.

“The economy certainly won’t prompt any more ECB action for now,” said Aurelio Maccario, chief euro-area economist at Unicredit Group in Milan, who expects the ECB to keep rates on hold until the end of 2010. “However, if credit flows don’t start improving, Trichet will have to put his thinking cap on again in a few months.”

Story from Bloomberg

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