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UPDATE 1-ECB to hold rates, Trichet's take on turmoil key

Thu, Oct 2 2008, 08:16 GMT
http://www.afxnews.com

FRANKFURT, Oct 2 (Reuters) - The European Central Bank is expected to keep interest rates on hold on Thursday, with financial markets awaiting President Jean-Claude Trichet's take on whether global financial turmoil has affected the rate outlook.

The key is whether Trichet and his ECB colleagues believe the ructions of the last few weeks have inflicted enough damage on the euro zone's economy to warrant possible interest rate cuts, even though inflation remains far above target.

All 81 analysts polled by Reuters expect the ECB to leave rates at 4.25 percent when the Governing Council announces its monthly decision at 1145 GMT. But after a month when the credit crisis has claimed some of the biggest names on Wall Street and spread into Europe, markets will be looking to the future.

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. But the plan faces a final hurdle in the House of Representatives, which rocked markets this week by rejecting an earlier version.

"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."

Having hit a record 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.

Policymakers began their meeting at 0700 GMT, and Trichet will hold his post-rate decision news conference at 1230 GMT.

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

Since the ECB last met, gloomy economic data and a rise in unemployment have suggested a euro zone recession is increasingly likely while inflation fears have been eased by further drops in oil and commodity prices.

The collapse of Lehman Brothers, an unprecedented run of bank rescue deals and evidence that Europe has been sucked into the credit crisis have also fanned pessimism about the economy.

Interest rate futures imply rates will fall to 4.0 percent by the end of the year, falling 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.

(For details please double click on [ECB/INT])

Some European politicians are also urging the ECB to think about rate cuts. France's European Affairs Minister Jean-Pierre Jouyet said on Wednesday that the ECB should factor in the impact on the economy of the recent financial market pandemonium. ([ID:nL1642695])

But the ECB is no stranger to French political buffeting 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 that fact 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 LloydsTSB.

INFLATION PROPHET

Last month Trichet said inflation would drop back under the bank's 2 percent ceiling only in 2010. But with the market carnage posing a fresh threat to the economy and expected to fuel further drops in oil and commodities prices, some analysts believe it will come back in line sooner.

"The key comment remains the one about the medium term risks to inflation," said RBS's Claase. "If that changes significantly then that will really mark a shift." However, this remained an unlikely scenario, he added.

"The fear of second-round effects ... may tie the ECB's hands for the time being," said UniCredit analyst Nikolaus Keis.

Second-round effects such as overgenerous wage increases and excessive price rises are the ECB's biggest fear as they create the threat of a damaging price spiral. Adding to concerns, Germany's most powerful trade union, IG Metall, is demanding an 8 percent pay rise for its workers.

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

tf.TFN-Europe_newsdesk@thomsonreuters.com

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