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ECB to hold fire as euro zone economy shows glimmers of hope

An illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in the late evening in Frankfurt January 8,
An illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in the late evening in Frankfurt January 8,

By Sakari Suoninen and Eva Kuehnen

FRANKFURT (Reuters) - The European Central Bank is expected to keep interest rates at a record low of 0.75 percent on Thursday, refraining from a cut as the euro zone economy shows some signs of stabilising and inflation still tops its target.

The 17-country euro zone is in recession, but recent data points to some stabilisation, and ECB President Mario Draghi could strike a slightly more positive tone in the news conference that follows the rate decision.

"Rates are definitely on hold. Nothing has been spectacular enough in recent data to force the ECB to any action," Deutsche Bank economist Gilles Moec said.

"There is a recession, but no further deterioration. Lending is weak, but also not deteriorating further, so the ECB is not compelled to act."

The 23-man Governing Council will find some comfort from improving business morale as well as a survey of purchasing managers, which gave tentative signs that the worst of the downturn may have passed.

"Since the December meeting key figures have generally surprised on the upside," Nordea analyst Anders Svendsen said in a note to investors.

While the ECB had, in Draghi's words, "a wide discussion" on reducing rates last month, the grounds for such a move have not grown and Executive Board members have argued against a cut.

Yves Mersch said last month he did not see the logic of a debate about the ECB cutting its main rate and Peter Praet said there was little room to cut.

Another cut of the refinancing rate would raise the question of whether the ECB would also lower its deposit rate - currently at zero - by the same amount, which would push it into negative territory, essentially charging a fee, for the first time.

Even though Draghi has said the bank was "operationally ready" for such a step, it has grown increasingly wary of the idea over the past couple of months, a source with knowledge of the ECB's thinking said.

Negative deposit rates could deal a hefty blow to money market funds, which have already seen cash outflows since the ECB cut the deposit rate to zero in July. The rate is a peg for short-dated money market rates and at zero it is already almost impossible for funds to generate a return for their investors.

Executive Board member Joerg Asmussen said last month he would be "very reluctant" about the ECB cutting the deposit rate any further, adding that "our (monetary) policy is very accommodative".

INFLATION STUBBORN

ECB staff projections published last month saw inflation at about 1.4 percent in 2014, which would usually justify another interest rate cut.

The central bank also sees inflation falling below 2 percent this year with underlying price pressures remaining moderate.

But inflation has eased more slowly than the ECB initially expected and as long as it misses the target - it has been above 2 percent for more than 2 years - a cut could be difficult to justify.

Furthermore, in the euro zone's largest economy, Germany, prices rose faster in December than in the previous month.

In addition to gauging whether the ECB is entertaining another cut or not, Draghi will be pressed on what other options the ECB has, especially to improve lacklustre bank lending.

ECB data showed last week that bank lending to the private sector fell at an annual rate of 0.8 percent in November.

At his December news conference, Draghi attributed the drop mainly to demand factors, but added that in a number of countries, credit supply is restricted.

A move by global regulators to give banks more time and flexibility to build up cash reserves is expected to do little to support a recovery in Europe, where recession-hit firms and households have scant appetite for more debt.

"One thing the ECB needs to engineer is recovery in lending," Rabobank economist Elwin de Groot said.

(Reporting by Sakari Suoninen. Editing by Jeremy Gaunt.)

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