ECB Holds Rates Steady

The European Central Bank held interest rates at 1.0 percent on Thursday and will resist calls to do more to fight the euro zone crisis, putting the onus on governments to foster growth and head off anger over austerity policies.

Police mounted a heavy presence outside the Barcelona hotel where the policymakers were meeting, ahead of protests expected against the Spanish government's spending cuts that are supported by the ECB.

Financial markets want the central bank to step up its efforts to fight the crisis by buying Spanish government bonds to reduce borrowing costs for the country which is in recession and has unemployment that is twice Europe's average.

But ECB policymakers are more likely to praise Spain's cost-cutting drive than to announce any new policy action such as restarting their bond-buying programme.

Investors will focus on whether President Mario Draghi uses his 1230 GMT news conference to open the door to easing policy later this year if the crisis gets worse. The ECB has never before cut its main interest rate below 1.0 percent.

"We expect he is going to sound mildly dovish and more careful on growth, at least pointing to downside risks emerging again, but there will be no concrete signals for actions," said Anders Svendsen, chief analyst at Nordea bank.

"For now, it is still too early for the ECB to change its view, but the risk of an interest rate cut during the summer has clearly increased," he added.

The ECB has pumped over 1 trillion euros into the financial system in recent months, smoothing debt issuance for euro zone members. But Spanish bond yields jumped at a debt auction held as the 23-member ECB Council met, though demand was solid.

Draghi helped shift the tone of the economic policy debate in the euro zone last week when he advocated a "growth compact" without spelling out exactly what he meant.

French presidential candidate Francois Hollande, who wants to step away from German-inspired austerity, has welcomed Draghi's comments and the ECB president will be pressed to flesh out his growth vision.

Draghi has so far pressed governments to shape up their economies with structural reforms but there is growing resistance to spending cuts that governments across the euro zone are making to streamline public finances.


The Italian is under pressure to limit the ECB's role from Bundesbank chief Jens Weidmann, who wants countries to put their finances in order rather than looking to the central bank.

"A consistent budget clean-up and determined structural reforms are the best growth policy, because that way trust is achieved and economic performance is strengthened," Weidmann told German weekly newspaper Die Zeit.

Draghi also faces resistance from the powerful Bundesbank to any potential rate cut or a reactivation of the bond-buy plan.

"The euro crisis has not escalated to such an extent recently that he would want to take on the Bundesbank on that," Berenberg Bank economist Holger Schmieding said of the bond-buy programme.

The ECB has left its bond-buy plan dormant for the last seven weeks despite a rise in benchmark Spanish yields to 6 percent. A break above that, to 7 percent, is considered an unsustainable price to pay to refinance its debt.

Weidmann told Reuters last month Spain should take the rise in its bond yields as a spur to tackle the root causes of its debt woes and not look to the ECB for help.

A Reuters poll taken last week showed three-quarters of economists saw the ECB restarting its bond purchases within the next three months. However, most money market traders said in a separate poll the bank would not buy more bonds.


Spain and its problems are at the heart of a downturn of confidence in the euro zone, where fatigue with austerity is growing just as the economy shows signs of deteriorating.

The euro zone purchasing managers' index (PMI) showed the euro area's private sector slump deepened in April at a faster pace than any economist polled by Reuters predicted, dampening hopes the region will emerge from recession soon.

The prospect of the euro zone as a whole following Britain into recession has set markets wondering whether the ECB could pave the way for a rate cut later this year. It has never before lowered its main rate below 1 percent.

Draghi said last week any "exit strategy" from the ECB's emergency measures - long-term lending operations and the dormant bond plan - was premature given weak economic conditions and he has not ruled out cutting rates below 1 percent.

"He will probably emphasise the downside risks to growth without getting close to signalling a rate cut for June," said Berenberg's Schmieding.

"A June cut is not likely but it is not impossible and he will likely keep the options open when asked about it."

ECB Vice-President Vitor Constancio said after the publication of the PMI data there were "very significant" risks to the economy, adding the bank would adapt its policy if those risks became a reality, as it did when it cut rates last year.

If that view makes it into the ECB policy statement, rate cut expectations that have begun to creep back into market pricing in recent weeks are likely to firm rapidly.