ECB holds rates, waiting to see how recovery fares
Paris: The European Central Bank left interest rates unchanged on Wednesday, holding off any fresh policy action for now while it waits to see whether a fragile euro zone recovery strengthens.
Financial market attention now shifts to ECB President Mario Draghi's 1230 GMT news conference, at which he is likely to keep open the options of an interest rate cut or a bumper cash injection into the banking system should the euro zone outlook sour.
The ECB has grown concerned about market interest rates, which moved higher over the summer at the prospect of the U.S. Federal Reserve unwinding its stimulus.
Seeking to guide them down, the ECB said in July it would keep its rates at current or lower levels for an "extended period", its first use of forward guidance.
The ploy struggled to gain traction until the Fed last month delayed unwinding its stimulus. Investors will gauge how dovish Draghi sounds after the decision to leave the ECB's main interest rate at 0.5 percent.
The central bank also left the rate on its deposit facility at 0.0 percent and held its marginal lending facility - or emergency borrowing rate - at 1.00 percent.
"This is as expected," Berenberg bank economist Christian Schulz said of the rate decision. "The economy is recovering, there is little pressure to cut rates at the moment. At the same time, inflation is low and plenty of downside risks are out there, so there is no pressure to tighten policy quickly."
Last week, Draghi underlined the ECB's readiness to act, saying that, if needed, it could use another LTRO - ultra-long loans it issued in late 2011 and early 2012 to pump over 1.0 trillion euros into the system.
A majority of economists in a Reuters poll expect the ECB to keep its key rate at 0.5 percent until at least April of 2015. But they also expect it will serve up another course of LTROs to banks, possibly by the end of this year.
"They could announce a follow-up for the 3-year LTROs later this year," said Schulz. "The idea would be that nobody gets worried about liquidity getting tight next year."
Excess liquidity - the amount of money beyond what the banking system needs to function - has fallen to 221 billion euros from over 800 billion early last year, approaching a level expected to push market rates closer to the ECB's main rate.
The excess has fallen as banks repay the LTROs they took from the ECB in late 2011 and early 2012 and the ECB is concerned that higher short-term market rates that banks use when lending to each other could hurt the euro zone's recovery and push inflation further below target.
ECB Executive Board member Benoit Coeure said last week the bank was monitoring money market rates and had a number of tools it could use if needed.
"It's not an urgent decision," he said.
The euro zone economy is broadly sticking to the ECB's scenario for a slow recovery. Inflation slowed to 1.1 percent in September - its lowest since February 2010 and a level that allows the ECB to maintain its loose monetary policy.
However, manufacturing growth in Italy and Spain eased off in September, highlighting the fragile state of the recovery in the euro zone periphery. Battered Greece's contraction deepened.
Italy's political troubles - keeping a fragile coalition government from having to call new elections - are also in the background, but the ECB does not usually get involved publicly in such matters.
"I don't see the Council budging an inch in response to the latest Italian crisis," said RBS economist Richard Barwell. "Like parents trying to bring out the best in their children, council members are trying hard to be consistent and predictable and impervious to melodrama in their dealings with politicians."
A new LTRO could aim to raise excess liquidity, and ease banks' funding situation before the ECB's asset quality review (AQR) next year, a precursor to its new supervisory role.
But the fall in market rates has relieved some of the pressure to act, and the ECB risks disappointing markets if banks, which have been repaying early some of the twin LTROS from 2011 and 2012, show little interest in additional loans.
The forward rate which shows where one-year Eonia rates are seen in a year's time, has fallen to levels last seen in July when the ECB launched its forward guidance.