Markets watch European Central Bank for exit plan

LONDON: The European Central Bank is expected to keep its benchmark interest rate unchanged at the historic low of 1 percent Thursday - and could indicate the eurozone won't see growth strong enough to warrant a hike for quite a while.

Figures later this month are expected to show the 16 countries that use the euro joining the U.S. in leaving recession.

Its two largest economies, Germany and France, officially returned to growth during the second quarter.

But the economic outlook is for weak growth at best, and below-target inflation for the year ahead.

Figures last week showed that unemployment rose to a 10-year high of 9.7 percent in September, while consumer prices fell for the fifth consecutive month in October.

Both are signs of a slack economy.

Most analysts think it will take a very strong rebound over a long period of time to make up for the output lost during the recession and stoke inflationary pressures.

The International Monetary Fund projects that the euro area will have contracted by a massive 4.2 percent in 2009 even after growing in the third and fourth quarters of the year.

"Rates are likely to remain low for a protracted period," said Marc Ostwald, a strategist at Monument Securities, adding that a rate hike before the second half of 2010 still looks "very, very unlikely."

What's more, there are mounting concerns within the bank and in member governments that the rising euro will derail the fledgling economic recovery.

A higher euro makes exports more expensive, and exports are particularly important for Germany, the single currency bloc's largest economy.

Currency traders will therefore be focusing in on Thursday's press conference from ECB president Jean-Claude Trichet to see whether his concerns about the euro's value have increased over the last month.

On Oct. 23, the euro climbed to a 14-month high of $1.5060 before slipping back modestly since.

After October's rate-setting meeting, Trichet cited the joint statement from the Group of Seven finance ministers and central bankers, saying the ECB continued to monitor exchange markets closely.

He said "excess volatility" and disorderly movements in exchange rates could hurt economic and financial stability.

"At the very least, the single currency's strength will make the Bank more reluctant to hike interest rates," said Jennifer McKeown, European economist at Capital Economics.

Markets are looking to see if the European Central Bank looks to reduce its lending to commercial banks once recovery is on a sound footing.

Most analysts still think the European Central Bank will wait until December to provide markets with more clarity about its exit strategy.

Still, Axel Weber, the president of Germany's Bundesbank and a member of the ECB's governing council, has asserted that crisis measures could be rolled back next year.

Weber said the first step was likely to involve the scaling back of "very long-term" loans to banks.

"While we have maintained our view that further clarity and official announcements from the ECB will most likely come at the time of the December press conference, the possibility that it may come as early as Thursday's meeting has increased following Weber's comments," said Silvio Peruzzo, eurozone economist at Royal Bank of Scotland.

The European Central Bank has been criticized in many quarters for not cutting interest rates as far and as fast as the U.S. Federal Reserve.

But it has instead provided massive liquidity injections to commercial banks to get them lending to businesses.

Over the last year, the ECB has significantly expanded those operations, providing funds over a longer period and at low interest rates.

Analysts said Weber's comments last week will likely mean that the bank will stop giving 12-month credits in December, and that the 3-month and 6-month support packages will become less frequent over the coming months.

The Bank of England is expected to back calls to expand the amount of money it pumps into the British economy, which unexpectedly stayed in recession in the third quarter.

At present, the Bank of England can buy up to 175 billion pounds ($285 billion) of financial assets, such as government bonds, from the banks.

The aim of the policy is to increase the money supply in the hope that eventually the banks will start lending more to the private sector.

Most analysts think it will increase its asset purchase program by at least 25 billion pounds. - AP

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