ECB reviews bank support, holds rates

Reuters News
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Posted: Mar 22, 2011 10:07 AM
ECB reviews bank support, holds rates

By Paul Carrel

FRANKFURT (Reuters) - The European Central Bank left interest rates at record lows on Thursday but will step up its anti-inflation rhetoric and may curtail some crisis support measures as it prepares the ground for a rise later this year.

ECB President Jean-Claude Trichet will present upward revisions to the central bank's inflation and growth forecasts after a monthly meeting of its policymakers, several of whom have recently expressed concern about firming price pressures.

The ECB held interest rates unchanged at the record-low 1.0 percent they have been at since May 2009.

"No surprise," said Citigroup economist Juergen Michels.

"I think when it comes to the price assessment they will talk about 'upside risks', and then suggest that at some stage they go ahead with a rate hike," he said. "I expect them to start with a first rate hike in the third quarter."

Trichet, whose ECB presidency expires in October, holds a news conference at 1330 GMT (8:30 a.m. EST). Thursday's policy meeting was not attended by Bundesbank chief Axel Weber, who shocked markets last month by dropping out of the race to succeed Trichet.

Bundesbank Vice President Franz-Christoph Zeitler took Weber's place.

The ECB faces accelerating inflation but its readiness to restart its 'exit strategy' may be limited by doubts about whether EU leaders will agree later this month to bolster Europe's rescue fund.

A Reuters poll late last month showed a majority of economists expect the ECB will hold fire on raising rates until at least October, though an increased minority saw a hike in the third quarter.

Euro zone inflation quickened in February to 2.4 percent, its highest level since October 2008, remaining above the ECB's target of below but near 2 percent for the third month running.

Tougher rhetoric on inflation would require a neat pirouette from Trichet, who last month appeared to soften his tone on the threat posed by price pressures after jolting markets in January with noticeably sharper language.

Should EU leaders fail to come up with a comprehensive package to tackle the euro zone's sovereign debt crisis at their March 24/25 summit, markets could turn more negative on the bloc's peripheral countries, further delaying the central bank's exit from crisis measures.

Trichet has called for European leaders to give the rescue fund, the European Financial Stability Facility (EFSF), maximum flexibility in both size and scope.

BANK SUPPORT IN BALANCE

German resistance to boosting the rescue fund has heightened uncertainty about the summit outcome and this could impact the ECB's willingness to restart its withdrawal of emergency support for banks even though money markets have begun normalizing.

"It's increasingly clear that on March 25 we'll have some kind of result but probably not the comprehensive solution that was hoped for," said Deutsche Bank economist Gilles Moec.

"Then the ECB has to take the tab basically -- continue with the SMP (bond buying program) and maintain full liquidity."

Money market experts are evenly split over whether the ECB will restart the process of withdrawing its crisis support at Thursday's meeting or wait a little longer, a Reuters poll showed on Tuesday.

The half that see the bank restarting the phase-out process see it doing the minimum, ending limit-free longer-term funding and switching back to capped-limit, variable rate 3-month tenders.

The ECB's head of market operations Francesco Papadia said money markets were polarized, with banks in the periphery still dependent on the ECB for liquidity.

Borrowing from the ECB has dropped by 100 billion euros so far this year, sharply reducing the amount of excess cash that has distorted markets and pushing interbank rates back toward more normal levels.

HIGHER FORECASTS

The ECB will also reveal its latest set of staff economic projections and analysts expect to see them revised up given a strong run of euro zone data and evidence of building inflation.

The last set in December forecast inflation of between 1.3 and 2.3 percent for 2011 and 0.7 to 2.3 percent for 2012. Growth was seen at 0.7 to 2.1 percent in 2011 and 0.6 to 2.8 percent for 2012.

The numbers will not take into account the latest spike in oil prices due to unrest in the Middle East, however, meaning inflation numbers may not be as strong as some observers expect.

"In terms of policy implications, watch out for 2012 inflation. The closer (the mid-point of) this forecast is to 2 percent, the higher the chance of an early rate hike," ING economist Carsten Brzeski wrote in a research note.

(Additional reporting by Marc Jones, editing by Mike Peacock)