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ECB holds course in face of deflation fears

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(Globalpost/GlobalPost)

By David Milliken and Eva Taylor

FRANKFURT (Reuters) - The European Central Bank kept interest rates steady on Thursday despite a fall in inflation to its lowest in more than four years, counting on the euro zone recovery to gain strength unaided.

The ECB held its main interest rate at a record low of 0.25 percent and the rate for bank deposits at central banks at zero, refraining from taking more drastic measures in the face of fears that the euro zone could slip into deflation.

A slowdown in euro zone inflation in March to levels last seen when the economy was deep in recession in 2009 came as a surprise, but because it was driven by the kind of softer food and energy prices the bank usually judges as temporary it kept its course.

"The latest data were not strong enough to change the overall picture that was presented in the last meeting, therefore they left the rates unchanged," said Juergen Michels, chief economist at BayernLB.

There was little market reaction to the news.

The focus now shifts to a news conference with ECB President Mario Draghi, due to start at 8.30 a.m. GMT, where he is expected to explain the central bank's decision and markets will watch out for any comments that may indicate possible action ahead.

"The ECB is likely to give a very strong verbal message that they are willing to take further action on both the rate side as well as on the side of quantitative easing (QE)," Michels said.

"The focus would be more about the ability to use QE, which does not mean that they will act on that front in the very near term, but to make clear that QE is not a theoretical tool, but rather a tool in the tool box that could be used in practice."

Policymakers have been willing in recent weeks to publicly broach cutting deposit rates below zero - effectively charging banks to hold cash with the ECB - or embarking on bond purchases as the United States, Japan and Britain have, if the threat of deflation became more acute.

Draghi is likely to want to play up the ECB's readiness to tackle downside risks to inflation, in order to stem a rise in the euro, which last month hit its highest level against the U.S. dollar since October 2011 and has a dampening effect on import prices the more it climbs.

"A combination of persistent top-line inflation weakness and persistent upward pressure on the euro will probably result in more dovish ECB rhetoric on the central bank's willingness to fight downside risks to inflation," said Lena Komileva, managing director of G+ Economics.

Pressure from abroad to act has mounted, most notably from the International Monetary Fund.

"More monetary easing, including through unconventional measures, is needed in the euro area," IMF head Christine Lagarde said in a speech on Wednesday, outlining the Fund's policy recommendations ahead of its spring meetings next week.

YEARS OF LOW

The ECB's rate decision was broadly expected. <ECB/REFI>

Last month, the ECB forecast it would take 2-1/2 years for inflation to rise to 1.7 percent, which even then would barely meet the target for annual price growth below but close to 2 percent.

That was insufficient to prompt a majority of policymakers to back more monetary stimulus at the time, and to change their minds now would have gone against the central bank's practice of not reacting to short-term moves in data.

That said, the ECB did cut its main interest rate in November after a surprise drop in inflation in October to 0.7 percent.

Other economic indicators are similar to last month's, suggesting the ECB outlook that the euro zone will record economic growth of around 1.2 percent this year - the highest since 2011 - holds good.

Nonetheless, there may well be debate on the merits of future stimulus.

One option on the table is cutting the deposit rate that the central bank pays on the roughly 30 billion euros ($41 billion) deposited with it to below zero - effectively charging banks if they choose to hold money at the ECB rather than lending it out.

Such a move could temper the euro but there is less evidence that it would succeed in increasing lending.

Buying government assets with newly created money - as favored on a massive scale by the U.S. Federal Reserve, Bank of Japan and Bank of England - is a trickier prospect for the euro zone even though Bundesbank chief Jens Weidmann, normally a hardliner, has said it would be possible.

Only if deflation really looks like taking hold, will opposition to that be overcome.

($1 = 0.7249 Euros)

(Editing by Mike Peacock)

http://www.globalpost.com/dispatch/news/thomson-reuters/140402/ecb-set-hold-course-face-deflation-fears