ECB Set To Hold Fire On Rates, Eyes Risks From Ukraine Conflict

Frankfurt: The European Central Bank is set to hold fire on rates on Thursday as it waits for earlier stimulus measures to gain traction, while keeping an eye on emerging risks from the conflict in Ukraine.

The ECB cut interest rates to record lows in June, became the first major central bank to charge banks for holding their deposits overnight and launched a new ultra-cheap, four-year loan programme, dubbed TLTROs, to be rolled out later this year.

"After the fireworks in June, it is not the time to take fresh measures because the ECB wants to wait and see how things develop," said Reinhard Cluse, economist at UBS. "The ECB wants to keep its powder dry."

None of the 64 economists in a Reuters poll expect any change to the refinancing or deposit rates when the Governing Council meets on Thursday.

ECB President Mario Draghi is likely to put more emphasis on the geopolitical risks to the euro zone growth outlook after the European Union stepped up sanctions against Russia for its role in Ukraine's political crisis, which has already hit confidence.

Although all but two of 36 economists in a separate poll said there was a low risk of any negative impact on the euro zone economy from the U.S. and EU sanctions on Russia, they come at a time when key countries are struggling to return to growth.

Italy, the euro zone's third largest economy, slipped back into recession in the second quarter. Prime Minister Matteo Renzi has led calls to move from austerity to looser EU budget rules, but has been rebuffed by Germany, Europe's economic powerhouse, and some others.

In France, the region's second biggest economy which is also struggling, President Francois Hollande said the ECB and Germany must do more to boost growth and fight a "real deflationary risk" in Europe.

Against the backdrop of this debate, Draghi held talks with incoming European Commission chief Jean-Claude Juncker on Wednesday.

"DONE WITH EASING"

Euro zone annual inflation hit 0.4 per cent in July, the lowest since October 2009, though much was down to a sharp fall in volatile energy prices. UBS sees inflation picking up slowly from here, reaching 0.8 per cent towards the end of the year.

Low price pressures in the euro zone are also a result of reforms in some countries to regain competitiveness that include wage cuts and restrained government spending, which the ECB does not want to undermine.

The central bank has also taken heart from looser bank lending standards, indications of a pick-up in credit demand going forward and a weaker euro exchange rate, which hit a nine-month low against the dollar on Wednesday.

If, however, inflation remains stuck at low levels for too long and if inflation expectations start to deteriorate, the ECB says it stands ready to act, possibly with large-scale asset purchases, which are also known as quantitative easing.

"President Draghi is likely to reiterate the ECB's dovish stance, leaving forward guidance unchanged with the option to do more in the future (including QE)," said Frederik Ducrozet, senior economist at Credit Agricole CIB.

"But our baseline remains that the ECB is done with easing at this point."

Copyright: Thomson Reuters 2014