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ECB holds rates, Trichet's take on turmoil key

Thu, Oct 2 2008, 12:21 GMT
http://www.afxnews.com

FRANKFURT, Oct 2 (Reuters) - The European Central Bank left its benchmark interest rate at 4.25 percent on Thursday, and markets are now awaiting President Jean-Claude Trichet's take on whether global financial havoc has affected the rate outlook.

All 81 analysts polled by Reuters last week had expected the ECB to keep rates at a 7-year high for the third month in a row on Thursday, due to its concerns about above target inflation.

But there is growing evidence that the region's economy is suffering after more than a year of financial market turmoil, which has deepened dramatically in recent weeks.

"Leaving rates on hold is no surprise but the economic landscape in favour of such a decision is changing quickly," said UniCredit analyst Aurelio Maccario.

Trichet will deliver the Governing Council's first in-depth assessment of the latest financial market turmoil at a news conference at 1230 GMT, including what the crisis means for the health of the euro zone economy and its interest rate stance.

The key is whether ECB policymakers believe the ructions of the last few weeks have inflicted enough economic damage to warrant possible interest rate cuts in the next few months, even though inflation looks set to remain far above target.

"We are fairly sure that Trichet will acknowledge that the last few weeks have increased the downside risks to the wider economy," said Royal Bank of Scotland economist Gareth Claase. "If he then also tones down his stance on inflation then, yes, it could pave the way for rate cuts."

"However, we think he may say that the appropriate response was injections of liquidity and capital, and that it is not necessary or helpful to adjust interest rates at the current juncture. That could surprise people on the hawkish side."

The euro was little changed against the dollar after the decision but European stocks pared gains.

Among economists there is a now a growing belief that rate cuts are inevitable, the only question is when.

The collapse of Lehman Brothers, an unprecedented series of bank rescue deals and evidence that Europe has been sucked into the credit crisis has fanned pessimism about the economy. Gloomy economic data and a rise in unemployment suggest a euro zone recession is now increasingly likely.

Interest rate futures imply rates will fall to 4.0 percent by the end of the year, dropping further to 3.75 percent by February. Most analysts polled by Reuters, on the other hand, see a move only in the first quarter of 2009.

News that the U.S. Senate endorsed a reworked $700 billion bailout of the financial industry on Wednesday is likely to be welcomed by the ECB. However it is not a done deal. The plan faces a final hurdle in the House of Representatives, which rocked markets this week by rejecting an earlier version.

French President Nicolas Sarkozy will host a meeting on Saturday with the leaders of Britain, Italy and Germany plus Trichet to discuss the financial crisis.

But prospects for a European equivalent to the U.S. bailout appear weak after Germany and France clashed over behind-the-scenes plans for a government-funded safety net.

POLITICAL BUFFETING

France's European Affairs Minister Jean-Pierre Jouyet also asked the ECB to factor in the likely economic impact of the financial market pandemonium when it sets rates.

But the ECB is no stranger to French political pressure and analysts believe it will wait for the dust from the recent turbulence to settle before reassessing its rate stance.

"We expect them (the ECB) to touch on weaker growth and the fact that inflation is coming down, but we expect them to keep the separation between monetary policy and measures it is taking to deal with the credit crisis," said Jeavon Lolay, a senior economist at Lloyds TSB.

But the chances of rate cuts have been improved by recent slides in oil and commodity prices which have helped rein-in near-record inflation.

Having hit 4.0 percent in June and July, inflation fell for the second month in a row in September to 3.6 percent but it remains well above the ECB's ceiling of 2 percent.

(Reporting by Marc Jones; editing by David Stamp) Keywords: ECB RATES/

tf.TFN-Europe_newsdesk@thomsonreuters.com

cmr

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