September 8, 2011 / 8:34 AM / 7 years ago

ECB signals rates on hold, nervous about economy

FRANKFURT (Reuters) - The European Central Bank signaled on Thursday that it had halted a cycle of interest rate rises begun just five months ago, saying euro zone inflation risks were no longer skewed to the upside and economic growth would be slow at best.

ECB President Jean-Claude Trichet said there were “intensified downside risks” to the economic outlook for the 17-country euro zone, marking a significant change in stance from last month when the bank was focused on inflation risks.

“The change in tone firmly shelves rate hikes and even opens the door to rate cuts if the economic outlook deteriorates further,” said ABN Amro economist Nick Kounis.

Trichet said inflation should fall below 2 percent in 2012 from 2.5 percent last month, and that price risks were “broadly balanced”. That assessment marked a change from last month, when he said there were “upside risks to price stability”.

“We expect the euro area economy to grow moderately, subject to particularly high uncertainty and intensified downside risks,” Trichet told a news conference after the ECB left rates at 1.5 percent, following hikes in April and July.

The euro tumbled in response to the gloomy economic prognosis. A month ago, the ECB chief had said risks to the growth outlook were balanced.

“We are in a situation which is exceptionally demanding,” Trichet said, making an impassioned defense of the ECB’s record and its handling of the euro zone debt crisis when asked about calls from some in Germany for a return to the Deutschmark.

The ECB had delivered price stability “impeccably”, he said, holding his last monthly news conference at the ECB’s Frankfurt news conference before his term expires at the end of October. Next month, the ECB Governing Council meets in Berlin.

“I would like very much to hear the congratulations for an institution which has delivered price stability in Germany over almost 13 years at 1.55 percent approximately ... which is better than what has ever been obtained in this country over the last 50 years,” he said, raising his voice and visibly moved.

He also took aim at Germany, France and Italy for watering down the budget rules in Europe’s Stability and Growth Pact, saying this contributed to the fiscal mess that ultimately pushed the ECB into buying up the debt of troubled economies on bond markets.

“If we have embarked into the SMP (bond) was because the governments in question had not behaved properly.”


ECB staff cut their growth forecasts to a range of 1.4-1.8 percent this year from the 1.5-2.3 percent seen in June. Next year, growth is expected to be between 0.4 and 2.2 percent, down from 0.6 to 2.8 percent previously.

Inflation is now predicted to fall back to between 1.2 and 2.2 percent next year, for a midpoint of 1.7 percent, which would be below the central bank’s target of close to but below two percent.

“A very thorough analysis of all incoming data and developments over the period ahead is warranted,” Trichet said. “We will continue to monitor very closely all developments.”

All 75 of the economists polled by Reuters ahead of the ECB’s decision correctly forecast rates would stay on hold at this meeting.

Following the two rate rises earlier this year, all the signs from policymakers were that further rises had also been penciled in but a deterioration in the economy and debt crisis since then has altered the outlook dramatically.

Policymakers’ failure to resolve the debt crisis has eroded confidence in the euro zone, and some private sector economists put the chance of a return to recession at least 50 percent.

While inflation remained at 2.5 percent last month, well above the ECB target, such is the concern about faltering growth that financial markets are pricing in a cut to rates as early as December.

Economists, who tend to take a broader view than that shown in market pricing, see an outside chance the ECB could cut in the months ahead, though such a U-turn would embarrass Trichet, who is unlikely to back a cut before his term ends next month.

“In our view, Trichet’s tone now indicates a neutral bias: faced with extremely elevated uncertainty, the next rate change could be either way, although we still think that the ECB’s first move to address persisting weakness will be to step up its non-standard measures rather than cutting rates,” said UniCredit economist Marco Valli.


Trichet said all the ECB’s extraordinary support measures — liquidity provision and its bond-buying plan - were “temporary in nature”, echoing a warning from his successor, Mario Draghi, earlier this week.

The ECB reactivated its bond-buying program a month ago to help hold down borrowing costs in Italy and Spain.

The ECB is concerned that by buying the sovereign bonds of Italy — the euro zone’s third largest economy — it is only encouraging the Italian government to slacken efforts to shore up its finances, and has been irritated by flip-flopping in Rome.

The ECB has recently appeared to be calibrating its purchases, allowing borrowing costs to rise to raise the pressure on Italy to implement its previously promised austerity measures.

Italy responded to the renewed attack on its bonds by pledging on Tuesday to hike value-added tax having dropped key parts of its austerity package the week before.

“We have confirmation that there is implementation of what was said in terms of overall results and that, of course, is of extreme importance,” Trichet said of the latest Italian measures, which were passed in the Senate on Wednesday and go to the lower house on Monday.

Additional reporting by Paul Carrel and Marc Jones, editing by Mike Peacock/Ruth Pitchford

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