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ECB holds rates, hints at all-or-nothing policy stance

The euro sign landmark is seen at the headquarters (R) of the European Central Bank (ECB) in Frankfurt September 2, 2013. REUTERS/Kai Pfaffe
The euro sign landmark is seen at the headquarters (R) of the European Central Bank (ECB) in Frankfurt September 2, 2013. REUTERS/Kai Pfaffe

By Leika Kihara

FRANKFURT (Reuters) - The European Central Bank left interest rates on hold and unveiled no other measures to bolster a fragile euro zone recovery on Thursday, despite forecasting low inflation for years to come.

ECB President Mario Draghi also described as "relatively limited" the benefits of one technical option for loosening lending conditions, suggesting the bank will either do nothing or else take bold policy action should the outlook deteriorate.

The ECB left its main interest rate at 0.25 percent, a move generally expected by markets, and held the deposit rate it pays banks for holding their money overnight at zero.

Draghi said the latest economic information suggested recovery was on track and needed no extra push for now.

"We saw our (economic) baseline by and large confirmed," he told a news conference after what he described as a "broad discussion" on interest rates, and other policy instruments.

"The news that has come out since the last monetary policy meeting is also, I would say, by and large on the positive side."

The euro jumped against the dollar to its highest since December and to a peak against the yen not seen since January 23 after the ECB signaled no need for new economic stimulus.

Inflation has been in what Draghi calls the "danger zone" below 1 percent for five months now and was running at 0.8 percent at the last count.

The lack of action was significant, since last month Draghi had signaled that by the March policy meeting the ECB would have enough information to judge the need for fresh stimulus.

An ECB source had predicted before the meeting the ECB would agree to stop operations to soak up money spent on Greek and other countries' bonds at the height of the euro crisis. But the ECB held off this option and Draghi played down the impact it would have.

RBS economist Richard Barwell said ending the drain operations would have achieved little.

"So the message is 'we'll either do something meaningful, or nothing at all'," Barwell said. "Token gestures are off the table."

Like the Bank of Japan, which meets to set policy next week, the ECB is running out of room to cut interest rates, putting the onus on alternative policy measures.

ECB policymaker Ewald Nowotny told Reuters last month that he and his colleagues were nearing unanimity on the option to end the so-called sterilization operations.

"LIMITED BENEFITS"

The resultant release of around 175 billion euros ($240 billion) would have roughly doubled the amount of excess liquidity in the financial system, helping to bring down interbank lending rates.

The move would also have marked a big philosophical shift and a step towards U.S.-style quantitative easing (QE).

However, Draghi said there was no sign of back-door monetary tightening via rising money-market rates and therefore no need to act, for now at least.

"The benefits of such sterilization are relatively limited given the short maturity of the bonds currently present in the SMP (sovereign bond) portfolio," he said.

"So the injection of the liquidity would really last only a relatively short time, less than a year for sure," he added.

New forecasts from ECB staff put inflation at 1.0 percent this year, 1.3 percent in 2015 and 1.5 percent in 2016 - below its target of close to 2 percent all the way through the projection.

"Annual HICP (EU harmonized) inflation rates are expected to remain at around current levels in the coming months," Draghi said. "Thereafter, inflation rates should gradually increase and reach levels closer to 2 percent."

The forecasts presume an unchanged exchange rate and falling oil prices.

Draghi rejected comparisons with Japan's experience of deflation, which became so entrenched that companies and households put off spending on expectations of lower prices ahead, leading to two decades of economic stagnation.

ECB policymakers have insisted that so far there is no sign of euro zone citizens deferring spending plans.

The International Monetary Fund believes more needs to be done, however. Reza Moghadam, head of the IMF's European Department, said in a blog on Wednesday that the ECB should cut interest rates and pump out more money, perhaps through QE.

"The analysis that we do at the present time ... diverges from what the IMF is saying," Draghi said.

Turning to tensions in Ukraine, he said trade links were insufficient to risk to suggest major risks for the euro zone.

But he described the growth impact on Russia as "severe", and said "the geopolitical risks in the area could quickly become substantial and generate developments that are unforeseeable and potentially of great consequence."

($1 = 0.7278 euros)

(Writing by Paul Carrel/Mike Peacock Editing by Jeremy Gaunt, Larry King)

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