ECB holds rates as economy shows glimmers of hope

FRANKFURT Thu Jan 10, 2013 6:31pm IST

A sculpture showing the Euro currency sign is seen through a photo board installed by Occupy protestors in front of the European Central Bank (ECB) headquarters in Frankfurt June 29, 2012. REUTERS/Alex Domansk/Files

A sculpture showing the Euro currency sign is seen through a photo board installed by Occupy protestors in front of the European Central Bank (ECB) headquarters in Frankfurt June 29, 2012.

Credit: Reuters/Alex Domansk/Files

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FRANKFURT (Reuters) - The European Central Bank held interest rates at a record low of 0.75 percent on Thursday, refraining from a cut following fledgling signs of life in the euro zone economy and with inflation still above target.

The 17-country euro zone is in recession but recent data points to some stabilisation and ECB President Mario Draghi might strike a slightly more positive tone in a news conference that follows at 1330 GMT.

Last month, Draghi said there was "a wide discussion" on reducing rates -- a comment that fed expectations a cut could soon follow. But hawkish remarks from a clutch of senior policymakers since have dampened that talk.

"This is not a surprise given some of the recent comments from the board, which did seem to play down the recent focus on interest rates," Nomura economist Nick Matthews said of Thursday's rate decision.

The euro rose against the U.S. dollar after the decision to $1.3115 from $1.3096 beforehand.

New ECB Executive Board member Yves Mersch said last month he did not see the logic of a debate about the ECB cutting its main rate and Peter Praet said there was little room to cut.

A Reuters poll published on Monday had pointed to the ECB keeping rates on hold, though the economists surveyed were split on the chances of a cut in the next few months.

Stronger survey data appeared to have strengthened the resolve of those at the ECB against a rate cut, Matthews said.

An improvement in euro zone business morale in December, when a survey also pointed to a slowing service sector contraction, suggest a modest turnaround in the bloc after a grim fourth quarter.

Another cut of the refinancing rate would raise the question of whether the ECB would also lower its deposit rate -- already at zero -- by the same amount, which would push it into negative territory, essentially charging a fee for banks to park money with it, for the first time.

Even though Draghi has said the bank was "operationally ready" for such a step, it has grown increasingly wary of the idea, a source with knowledge of the ECB's thinking said.

Negative deposit rates could deal a hefty blow to money market funds, which have already seen cash outflows since the ECB cut the deposit rate to zero in July. The rate is a peg for short-dated money market rates and it is already almost impossible for funds to generate a return for their investors.

Executive Board member Joerg Asmussen said last month he would be "very reluctant" about the ECB cutting the deposit rate any further.

INFLATION STUBBORN

ECB staff projections published last month saw inflation at about 1.4 percent in 2014, which would usually justify another interest rate cut. The central bank also sees inflation falling below 2 percent this year with underlying price pressures remaining moderate.

But inflation has eased more slowly than the ECB initially expected and as long as it misses the target -- it has been above 2 percent for more than 2 years -- a rate cut could be difficult to justify.

In addition to gauging whether the ECB is entertaining another cut or not, Draghi will be pressed on other policy options, particularly to improve lacklustre bank lending.

ECB data showed last week that bank lending to the private sector fell at an annual rate of 0.8 percent in November.

At his December news conference, Draghi attributed the drop mainly to demand factors, but added that in a number of countries, credit supply is restricted.

A move by global regulators to give banks more time and flexibility to build up cash reserves is expected to do little to support a recovery in Europe, where recession-hit firms and households have scant appetite for more debt.

"One thing the ECB needs to engineer is recovery in lending," Rabobank economist Elwin de Groot said.

A further question for Draghi will be how close he believes Ireland is to achieving the normalised market funding that would make it eligible for the ECB's new bond-buying programme.

"I would make the case but I'm not sure that the ECB would accept that case, but it's very close to it," John Corrigan, chief of Ireland's National Treasury Management Agency (NTMA) said on Wednesday.

(Reporting by Sakari Suoninen. Editing by Mike Peacock.)

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