Europeans expected to keep interest rate at record low

by Associated Press

Published: July 6,2010

Tags: economy, interest rate, world markets

BERLIN — The European Central Bank is set to leave its benchmark interest rate at a record low of 1 percent for the 14th straight month when it meets this week amid ebbing concerns over the health of the continent’s banking sector and a modest recovery for the euro.

With little prospect of rates changing soon, ECB President Jean-Claude Trichet can expect to face questions on banks’ demand for cash and the upcoming publication of “stress tests” on European banks — a move officials hope will help calm markets worried about the stability of the banking system.

As economic growth remains sluggish, recent data have underlined the ongoing lack of pressure on consumer prices in the 16-nation eurozone. Inflation fell to 1.4 percent in June from 1.6 percent in May — well under the ECB’s target of below, but close to 2 percent.

The ECB’s key refinancing rate has stood at 1 percent since May 2009, and there is little expectation that it will move any time soon.

With muted pressure on inflation, “the ECB looks ever more likely to keep interest rates down at the current level of 1 percent not only through 2010 but deep into 2011,” said Howard Archer, an economist at IHS Global Insight.

The Frankfurt-based central bank, whose governing council meets Thursday, “may well have to continue to engage in non-standard measures for some considerable time to come,” he added.

In May, at the height of the eurozone debt crisis, the ECB launched a program to buy government bonds — aiming to boost investors’ confidence in government debt and help eurozone countries avoid default. It hasn’t said how long that might last.

Still, last week brought signs of relief on another front as a record batch of unusual 12-month loans to banks expired smoothly. As the €442 billion ($557 billion) in credit came due, the ECB said it would lend a lower-than-expected €131.9 billion to banks for the next three months.

That uptake suggested that banks’ cash needs are easing despite lingering worries about the impact of the eurozone debt crisis. In a separate six-day tender, it lent €111.2 billion to banks that apparently are more upbeat about their long-term outlook.

The outcome helped lift the euro after a prolonged battering amid fears sparked by the debt crisis and European government austerity drives. The currency, which hit a four-year low below $1.19 on June 7, traded a little below $1.26 today.

With the outcome of last week’s operations, the ECB has “achieved its goal of regaining more of a grip on the money market,” said Carsten Brzeski, an economist at ING in Brussels.

Still, he cautioned that “some banks — not only at the periphery — are not out of the woods yet, and depend heavily on ECB funding.”

Market fears have focused on concerns that major banks are holding government bonds and other debt from the financially troubled countries such as Greece, Portugal and Spain — and could become victims of Europe’s simmering government debt crisis.

To dispel such fears, European Union leaders have promised to disclose the results of “stress tests” designed to show how banks would do if circumstances worsen.

French Finance Minister Christine Lagarde said last weekend that results will be published around July 23, and added that they will show European banks are “solid and healthy.”

ECB President Jean-Claude Trichet can expect to face questions on the tests at the news conference after Thursday’s rate decision.

“The EU bank stress tests could be a major step in limiting contagion and preventing all banks being tarred with the same brush,” Brzeski said. He added that “the success of the tests will crucially depend on clear communication of the results.”

The Bank of England also meets Thursday to consider monetary policy. It is widely expected to leave its base interest rate at a record low of 0.5 percent for the 17th consecutive month as the economic recovery remains fragile and public spending cuts are expected to hamper future growth.

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