ECB to reassure markets on 'exit' strategy

The European Central Bank's main challenge at its monthly policy meeting next week will be to persuade markets that it has no plans in the foreseeable future to start raising interest rates, analysts said.

Financial markets have been spooked by the announcement earlier this month that the US Federal Reserve is preparing to phase out its bond-buying or so-called "quantitative easing" programme, bringing the prolonged period of loose monetary policy to an end.

In response, sovereigns yields have risen across the euro area and financial conditions have generally tightened, albeit not dramatically.

It was enough, however, to persuade ECB officials to publicly proclaim that the period of low interest rates is not going to come to an end on this side of the Atlantic.

Central banks in the industrialised world have been keeping interest rates at all-time lows, thereby lending money cheaply, in a bid to stimulate the ailing economy.

The overall economic outlook for the 17 countries that share the euro "still warrants an accommodative stance and an exit is still distant," ECB chief Mario Draghi told a congress in Berlin last week.

And another top ECB official, executive board member Benoit Coeure, said: "At the current juncture, there should be no doubts that our 'exit' is distant and our monetary policy is and will remain accommodative."

ECB watchers are therefore convinced that while no new policy moves are on the cards at the bank's governing council meeting on Thursday, Draghi will be at pains to rule out any reversal in interest rates in the foreseeable future.

"With the news that the US Fed is set to taper its QE programme hitting eurozone financial markets, president Draghi should provide reassurance about ongoing ECB policy support," said Capital Economics economist Jennifer McKeown.

"While we do not expect policy changes this month, Draghi is likely to confirm that the ECB is considering various conventional and unconventional policy options," she said.

At its June meeting, the ECB held its key rate unchanged at a current record low of 0.5 percent and Draghi insisted at the time that the bank stood "ready to act to given the eurozone economy a much-needed shot in the arm.

But analysts are divided whether that will mean further cuts in interest rates, particularly as that would involve one of the ECB's key rates, the deposit rate, entering into negative territory.

The deposit rate has been held at zero percent since last year and taking into negative territory -- where the ECB would actually charge banks to park their cash with it -- could have unintended consequences, analysts say.

"Given the upbeat survey data since the meeting ... it is hard to see the council cutting rates," said RBS economist Richard Barwell.

"We remain of the view that a cut in the deposit rate into negative territory is highly unlikely. The most likely form of guidance is a statement that exit is 'very distant'," Barwell argued.

McKeown at Capital Economics disagreed.

"We still the that the bank's next move will be to reduce both the main refinancing and deposit rates to 0.25 percent and minus 0.25 percent respectively," she said.

"On the assumption that the economy fails to show convincing signs of recovery in the meantime, we are pencilling this move in for September."

Draghi has said in the past that the ECB is technically ready to mitigate any unintended consequences of negative deposit rates, even if it is not yet clear exactly how it will do so.

UniCredit economist Marco Valli said he expected "all interest rates to remain unchanged, and no announcement of further unconventional measures."

Since its last meeting, growth news has been positive, both with respect to soft and hard data, the economist noted.

"What the ECB will probably do is to use verbal intervention to 'talk down' eurozone yields, emphasising that the Fed and the ECB's monetary policy runs on two different tracks," Valli said.

"We expect Draghi to reaffirm that the ECB's monetary stance will remain accommodative for as long as needed, with the exit still far away.

"If yields do not fall back from recent highs and financial conditions do not ease in the next few weeks, the ECB will probably decide to respond with a quarter-point cut in the refi rate," he concluded.