• Home >
• News >
• Forex News

• Send
• Print
• Add To

PREVIEW-ECB seen on hold but under pressure to soften tone

Tue, Sep 30 2008, 12:58 GMT
http://www.afxnews.com

FRANKFURT, Sept 29 (Reuters) - The European Central Bank is forecast to keep interest rates on hold on Thursday but expectations are growing for policymakers to acknowledge increasing risks to growth from financial market mayhem and show they are prepared to support the economy by cutting rates.

Economists said the ECB could afford to soften its tough stance against price risks given inflation is on a downward path and should instead reassure markets that the central bank will do whatever is needed to defuse the growing market crisis.

"In the current environment, it's becoming increasingly difficult for the ECB to maintain the view that inflation remains the predominant concern," said Unicredit economist Marco Valli.

Since the last ECB meeting, commodity prices have fallen further, gloomy economic data suggest a euro-zone recession is increasingly likely, European banks have been dragged into the growing crisis of confidence among investors and the future of $700 billion U.S. bailout plan is uncertain.

Money market tensions are worsening despite massive central bank liquidity injections, with banks increasingly desperate for cash and pushing the rates at ECB auctions up to record highs.

Although the ECB maintains a strict separation between liquidity injections and official interest rates, economists said market turmoil would inevitably hurt the economy and the ECB had to recognise this.

"The issue is not whether we have a recession in the euro zone, it's how deep that recession will be," BNP Paribas economist Ken Wattret said.

"If they do wait a long while before lowering rates, I think this could be a very painful period for the economy."

In a Reuters poll last week, all 81 economists polled expected the ECB to keep interest rates unchanged at 4.25 percent on Thursday. Some have brought forward expectations of rate cuts to the fourth quarter, although the majority view is for no loosening until the first quarter of 2009 [ECB/INT].

Markets, however, fully expect the ECB to cut rates by a quarter percentage point to 4 percent by the end of the year and to 3.75 percent by February, and investors see a chance of the ECB acting in tandem with other global central banks.

INFLATION RISKS EASING?

When Trichet holds his news conference on Thursday, economists will be looking for any change to key phrases in his assessment of the outlook as well as any blunter recognition of the impact that market turmoil is having on growth.

In recent months the ECB has said it has "no bias" on rates, implying that its next move could be either up or down. It has also said current rates will contribute towards meeting its price stability goal, seen as a sign that no change is imminent, while at the same time saying price risks remain on the upside.

Euro-zone inflation fell to 3.6 percent in September and with lower commodity prices and slower growth, inflation could come into line sooner than the 2010 forecast made by ECB President Jean-Claude Trichet a month ago.

Consumer and business inflation expectations have dropped and market expectations, drawn from the yields on index-linked bonds, have fallen to between 1.7 and 1.9 percent over a 4-7 year horizon, from above 2 percent a month ago.

Input prices in the services and manufacturing sectors have also slowed, while activity contracted for the fourth month running, according to Purchasing Managers' Index data.

The euro-zone economy shrank in the second quarter and the weak data are fanning fears of a further contraction in the third, meaning a technical recession.

Economic sentiment sank to an almost seven-year low in September and business confidence fell in Germany, France and Italy, the three biggest economies. In a further worrying sign, unemployment is rising in France and Italy, although it fell more than expected in Germany.

RBS economist Jacques Cailloux said he expected the ECB to still describe price risks as on the upside, but give a gloomier assessment of growth.

"We expect the ECB to state that downside risks to the economic outlook have risen further," he said. "This would likely be interpreted as a dovish signal by the market and an important step towards easing."

Still, the risk was that concerns about price stability -- the ECB's primary mandate -- would overshadow growth and keep the ECB on hold for too long.

"I start to worry about a situation where the economic backdrop worsens further and still there is no recognition that the policy rate could be changed," Cailloux said. Keywords: ECB/

tf.TFN-Europe_newsdesk@thomsonreuters.com

cmr

COPYRIGHT

Copyright Thomson Financial News Limited 2008. All rights reserved.

The copying, republication or redistribution of Thomson Financial News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Financial News.