ECB leaves key rate at 1 percent

Published April 4, 2012 12:00PM (EDT)

FRANKFURT, Germany (AP) — The European Central Bank left its key interest rate unchanged at a record low 1 percent Wednesday while it assesses prospects for the region's debt-laden economy.

Investors waited for ECB President Mario Draghi's outlook at his post-decision news conference. He has said the bank expects a gradual recovery this year in the 17 countries that use the euro from low levels of economic activity, but there are still risks for a turn for the worse.

The decision by the 23-member governing council at the bank's Frankfurt headquarters comes at a meeting held a day earlier than usual because of the upcoming Easter holiday weekend.

The bank is regarded as locked in a holding pattern since making €1 trillion ($1.33 trillion) in cheap three-year loans to hundreds of banks, handed out Dec. 21 and Feb. 29. Monetary and credit indicators suggest that money will take time to feed through to the wider economy in the form of new lending to businesses and consumers.

The loans eased the credit crunch crippling the eurozone at the end of last year and steadied the region's banking system. But top ECB officials say they don't expect the money to immediately lead to credit expansion in a slack economy. Banks are hesitant to lend and businesses are seeing little reason to borrow in an uncertain environment.

The eurozone economy shrank 0.3 percent in the fourth quarter and indicators for future growth indicators remain weak, raising the likelihood that the economy shrank again in the just-finished first quarter. Two quarters of falling output are a technical definition of recession.

Government officials in countries such as Spain and Italy are concerned that slashing budgets and raising taxes to reduce debt and satisfy bond investors may hurt growth in the coming months as well. That would make it harder for indebted countries to dig out of the debt woes that have pushed Greece, Ireland and Portugal to take international bailout loans and raised concerns about Italy and Spain's ability to borrow affordably to maintain their own debt burdens.

The bank is unlikely to cut rates unless there's a significant turn for the worse. In part, that's because annual inflation of 2.6 percent remains stubbornly above its goal of just under 2 percent. The banks blames higher oil prices, not inflationary pressures from the economy.

The ECB loans also helped take easing borrowing for indebted governments such as Spain and Italy. Some of the banks that got the loans used them to buy their own government bonds, which drove down the government's cost of borrowing — or yields.

Draghi has stressed that the bank has done its part with the LTROs and two rate cuts in November and December, and that it is up to governments to cut their deficits and shake up their over-regulated economies to increase growth — the most reliable way of shrinking debt in the long term.

Capital Economics warned in a note Wednesday that "LTRO euphoria" is "starting to fade" because of downbeat signs for growth. That was underscored Wednesday when Spain's first bond auction held after unveiling a severe austerity budget raised only €2.6 billion, barely reaching the target of €2.5 billion to €3.5 billion.

The main message from Draghi and other top bank officials recently has been that the bank has the ability to take back the cash it flooded the markets with when the time is right — before an expansion in credit and lending contributes to inflation. Draghi has also stressed that the bank is managing risks from the wider assortment of assets it agreed to take as collateral for the loans.

Yet with the economy uncertain, it's highly unlikely the ECB will do more than look at ways to take back its cash it poured into the banks. Instead, economists at Royal Bank of Scotland say, discussion of a withdrawal of its cash is mainly aimed at discouraging expectations that the ECB would be willing to do more such longer-term refinancing operations, or LTROs.

"We expect President Draghi to confirm that discussion surrounding preparation of the exit is necessary as part of its communication that the ECB has reached its limit as far as support for the system is concerned," RBS analyst Nick Mathews wrote in a note to investors.

By Salon Staff

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