ECB Keeps Rates Unchanged

The European Central Bank kept its main interest rate on hold at a record low 0.5 percent on Thursday as it waits to see whether early signs of stabilization in the euro zone will blossom into an economic recovery.

Economic data improved in May and ECB President Mario Draghi said this week he still sees "a very gradual recovery" starting later this year, taking pressure off the ECB to act again, as it had promised to do if necessary after cutting rates in May.

"This can be seen as a reaction to the slight improvement in the purchasing managers indices (PMIs), which seem to signal that the worst is over in the euro zone," said David Kohl, chief economist for Germany at Julius Baer.

Investors will now shift their focus to the latest ECB staff projections - to be read out during a news conference that starts at 8:30 a.m. ET - to gauge how the central bank assesses the currency bloc's economic prospects.

Analysts expect only minor changes to the ECB's outlook from the previous forecasts, released in March.

"They will revise down GDP growth forecasts, while we expect next year's inflation forecast to remain unchanged," Unicredit economist Marco Valli said.

A firm majority of 81 economists polled by Reuters before Thursday's rate decision did not expect the ECB to cut its main refinancing rate or its deposit rate this month or in the near future. <ECB/INT>

But it will not rule out further policy action, if needed.

"Draghi will try to balance two messages. He will try to sound constructive about the economy and to also leave the door open to further policy easing," JP Morgan economist Greg Fuzesi said in a note to investors.

Purchasing managers index surveys on Wednesday showed euro zone business activity shrank in May, but at a slightly slower pace. Downturns have eased in France, Italy and Spain, and Germany is stabilizing, the data showed.

Inflation, which fell to 1.2 percent in April, rose back to 1.4 percent in May, closer to the ECB's target of just below 2 percent, while Eurostat confirmed the bloc's economy contracted by 0.2 percent in the first quarter of the year.

"If data were to disappoint going forward, then a refi rate cut becomes an option," ABN Amro economist Nick Kounis said.


One door the ECB will not close is the option of taking its deposit rate into negative territory from zero now - although few analysts believe it has immediate plans to do so.

At last month's post-rate decision news conference, Draghi said the central bank will look at negative deposit rates "with an open mind and we stand ready to act if needed".

But that might be ammunition the ECB wants to keep unused - at least unless the economy enters a downward spiral.

"It's not never-ever, but probably a lot would have to happen for it to happen," ABN Amro's Kounis said.

Other possible options could include moves to boost lending to small and medium-sized firms (SMEs), the economy's backbone, although plans to do so are unlikely to have been finalized.

Varying borrowing costs in different parts of the common currency area have developed into a major headache for the ECB, with firms and consumers in the debt-ridden south having to pay much higher interest rates than their counterparts in the north.

After months of hinting at action, the ECB has lately sought to temper expectations, warning against expecting a bazooka.

ECB Vice-President Vitor Constancio said last week that one should not "overblow" options the ECB has to repair the market for asset-backed securities, which could help access to funding when bank lending channels are blocked.

European Council President Herman Van Rompuy said on Friday he expected a joint proposal with the European Investment Bank to improve SME financing this month, although the ECB seems content to be a junior partner in any such scheme.


The Bank of England voted against restarting its bond buying on Thursday and left interest rates at a record low, bringing to a close Governor Mervyn King's final Monetary Policy Committee meeting.

The decision to leave policy unchanged before the arrival next month of King's successor, former Canadian central bank chief Mark Carney, was widely expected by economists, as recent data suggests Britain's recovery is gathering strength.

King, who is retiring from the bank after a 20-year career at the BoE, has argued since February, along with two other policymakers, for an extra 25 billion pounds ($38 billion) of bond purchases to boost Britain's sluggish economic recovery.

But they look set to remain in the minority on the nine-member MPC, most of whom seem to have felt that signs of recovery in the British economy mean there is no need for extra stimulus now.

King's retirement this month will mark the end of an era. He has voted at every MPC meeting since the BoE became independent in 1997 and was a driving force behind the asset purchase policy also known as quantitative easing.

As usual, the BoE issued no statement alongside its decision, and voting records for the MPC's June 5-6 meeting will not be published until June 19.

Although recent private sector surveys support the BoE's forecast that economic growth will pick up to 0.5 percent during the current quarter, last month some officials said there was still more scope to boost demand without pushing up inflation.

Inflation fell more than expected to 2.4 percent in April, but it has been above its 2 percent target since December 2009.