ECB keeps interest rates on hold

The bank's focus on inflation, rather than economic growth, remains unwavering, say analysts.

FRANKFURT // The European Central Bank (ECB) has left its interest rate unchanged at 4.25 percent as inflation fears outweigh the growing financial crisis that is creeping through Europe. But markets will be looking for clues from bank President Jean-Claude Trichet at a press conference later Thursday for hints that it could soon lower the rate from a seven-year high amid growing fears of a recession.
The 15-nation euro zone is fighting high inflation, low growth and dim short-term prospects for consumer and industrial demand as the global financial crisis unfolds. Worries that higher wages could stoke inflation were believed to have helped convince ECB governors that the time was not yet ripe for a rate cut. "Grave ECB concerns about rising wage inflation still make the bank reluctant to take the risk of cutting 'too soon,'" Gilles Moec, an economist at Bank of America had said ahead of the announcement.
Germany's IG Metall trade union launched wage talks with bosses on Thursday and is seeking an eight-per cent pay hike for 3.6 million workers -- the highest the union has sought in 16 years. Royal Bank of Scotland economist Dario Perkins said that weakening economic growth and lower oil prices "will be sufficient to warrant a reduction in interest rates next spring," in the northern hemisphere. The widely expected decision left the bank's other key rates -- the deposit rate and the marginal lending rate -- unchanged at 3.25 percent and 5.25 percent respectively.
Pressure on the bank to act might also have eased following the US Senate's passage of a US$700 million (Dh2.5bn) rescue package for banks that it was hoped would calm nervous markets. That legislation must still be approved by the House of Representatives, however. ECB policymakers focus on inflation, which has eased to 3.6 percent but is still way above the bank's target of just below 2.0 percent.
Jean-Claude Trichet, the president of the ECB, was likely to stress again at a press conference later on Thursday that fighting rising prices is the bank's top priority. But calls for rate cuts have multiplied, owing not only to the global financial crisis, but also because the 15-nation eurozone economy is flirting with a recession. Manufacturing activity fell again in September according to a key purchasing managers' index that languished in contraction territory for the fourth month running.
Unemployment has also started to creep back up in many eurozone countries. UniCredit Markets economist Aurelio Maccario said that "Trichet faces a tough job" when he speaks with media in balancing the need to acknowledge growth risks while keeping the focus on price stability. Capital Economics economist Jennifer McKeown added: "As inflation slows sharply, the ECB's full attention should turn to the weakness of the real economy."
Central banks including the ECB and US Federal Reserve have thrown lifelines to interbank money markets by pumping huge amounts of cash in a bid to keep credit flowing but those operations cannot resolve the crisis. The Fed's key interest rate now stands at 2.0 percent meanwhile, which does not leave it much room for manoeuvre to the downside. Many observers say the worst financial crisis since the 1930s Great Depression will only begin to improve when commercial banks regain enough faith in each other to begin lending on interbank markets again.
Against the backdrop of financial turmoil, analysts will listen closely for what Mr Trichet tells media about the bank's monetary policy and the economic outlook in general. If Mr Trichet repeates that "the current monetary policy stance will contribute to achieving our objective" of price stability, Mr Moec said it would signal that "rates will be on hold almost certainly for November and possibly well beyond."
If the phrase was eliminated from the ECB's statement, it could mean "that the rate cut could occur before the end of this year," he added.