European Central Bank to keep rates unchanged as it weighs up auction success

ECB to keep rates unchanged after massive auction

LONDON — The European Central Bank is expected to keep its key interest rate unchanged on Thursday and cautiously note some signs that the economy of the 16 countries that share the euro is stabilizing following unprecedented liquidity injections and big declines in the cost of borrowing.

As is so often the case, more attention will center on the ensuing press conference from the central bank’s president Jean-Claude Trichet than the actual interest rate decision itself.

Most analysts think that Trichet will say that the current interest rate is “appropriate” — indicating that it will not alter rates any time soon — and argue that it’s still too early to say whether last week’s massive 442 billion euro ($621.6 billion) liquidity injection is working despite some moderately better economic data.

Recent economic news, such as business sentiment surveys out of Germany, have suggested that the euro zone remains mired in recession but that the scale of the contraction in the second quarter will be less than the 2.5 percent quarterly drop recorded in the first three months of the year.

“While growing signs of stabilization and recovery should curtail further easing from the ECB, we see little chance of any tightening in the near term,” said David Page, European economist at Investec Securities.

Many members of the rate-setting governing council have indicated that they would not like the benchmark rate being reduced further from the current record low of 1 percent and have actually begun to talk about the need for exit strategies once economic recovery has been entrenched.

The European Central Bank has been criticized by many for not being as aggressive as the U.S. Federal Reserve or the Bank of England in cutting interest rates or pursuing unconventional measures, such as boosting the money supply.

In May, the European Central Bank cut its main interest rate to a record low of 1 percent as well as extending the maximum maturity of its bank lending from six months to 12 months and pledged to provide unlimited liquidity at the new, longer maturity.

Last Wednesday’s 442 billion euro 12-month money auction was widely seen as successful in that it managed to reduce interbank interest rates. Whether or not the declines get banks lending to each other — the main goal behind the liquidity injection — will take time to assess.

Last week, Axel Weber, the president of the Bundesbank and a key member of the governing council, warned banks that the European Central Bank could start lending to companies itself by buying up corporate bonds if the banks fail to kick-start lending following the liquidity injection.

“Even Weber, who had shown no enthusiasm for credit easing so far — to put it mildly — suggested that central banks would have to bypass the banks if the banks restrict credit and do not pass on the ECB’s generous refinancing conditions to households and enterprises,” said Guillaume Menuet, an economist at Merrill Lynch.

For now, the ECB will be looking for evidence that its liquidity injection is bearing dividends and is therefore not expected to announce any further “unconventional” measures aside from its recently announced limited program to buy 60 billion euro ($84.4 million) worth of euro-denominated covered bonds — a low-risk type of asset-backed securities.

The hope behind such a policy is that it may raise prices of assets on bank balance sheets, keep prices from falling for too long or too far, and well as giving the banking system more funds to lend to homeowners and businesses.

In contrast to the measures announced by the ECB, the Fed and the Bank of England have cut their interest rates to below 0.25 percent and 0.5 percent respectively and unveiled much larger programs to boost the money supply to get banks lending again.

Many analysts think the European Central Bank’s relative caution will likely mean that the euro zone recovers later and more slowly than the United States and possibly Britain. The Bank itself does not expect recovery to kick in fully until the middle of next year.

“With less convincing signs of improvement, a relatively cautious policy response and the worst of the credit crunch yet to materialize, the upturn in the euro zone will be weaker than elsewhere,” said Daniele Antonucci, European economist at Capital Economics.