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EUROZONE

Eurozone interest rates to hold despite slump

4 min

Analysts expect the European Central Bank will not change its main lending rates - currently at 4.25% - on Thursday, despite signs the eurozone economy is slowing down.

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The European Central Bank is widely expected to leave its main lending rate at 4.25 percent on Thursday despite growing signs of a sharp eurozone economic slowdown, analysts say.

The ECB will also release its latest forecasts for eurozone inflation and growth, with economists looking for signs that it is fully recognising the worsening trend.

"The bank's growth projections are likely to be distinctly lower," said Commerzbank analyst Michael Schubert.

"But because the upside risks for price stability remain high, the bank will continue to keep all its options open."

Inflation in the eurozone eased to 3.8 percent in August, down from a record 4.0 percent in July but still well above the ECB target of just below 2.0 percent.

While oil prices have come off the boil for now, there is concern that wage demands could create a second round of inflation pressures.

Eurozone economic activity is now clearly slowing however and pressure will build for the ECB to consider calls for it to loosen monetary policy, partly to help lower the value of the euro against the dollar which should help exports.

"The case for rate easing will intensify," UBS economist Sunil Kapadia forecast.

The ECB raised its main interest rate in July even though the economy contracted 0.2 percent in the second quarter -- the first time it has done so since the euro's creation in 1999 -- to ensure markets understood it was serious about fighting inflation driven by soaring energy costs.

"The ECB still suspects that wage inflation will intensify," Schubert said, especially since the powerful German IG Metall trade union is determined to seek pay raises of seven to eight percent when wage talks kick off shortly.

Maintaining high interest rates has kept the single currency strong against the dollar, hurting eurozone exporters whose wares are more expensive as a result.

In the United States by contrast, the Federal Reserve most recently held its rates at 2.0 percent after a series of sharp cuts from September.

Significantly, the US economy grew a better-than-expected 3.3 percent in the second quarter as strong exports came through to make up for domestic slack.

The Bank of England was also scheduled to review interest rates on Thursday, with analysts forecasting the key rate will stay 5.0 percent as it balances inflation against growth concerns.

After recent data, analysts are now focused on the prospects for slower eurozone growth as recession fears mount.

"Business surveys so far suggest that eurozone GDP (gross domestic product) will fall again in the third quarter, implying that the region is in the midst of a technical recession," said Capital Economics economist Jennifer McKeown.

A recession is commonly defined as two consecutive quarters of economic contraction.

Despite the trend, ECB governors were careful last week to highlight the risk they say is posed by excessive wage demands, undercutting expectations of an early rate cut.

"The ECB may be forced into a rate cut debate early next year," Bank of America economist Holger Schmieding said after pointing out that the M1 measure of money supply growth had fallen to 0.5 percent in July.

When inflation that month was taken into account, the volume of cash and overnight deposits in fact contracted by 3.5 percent, which Schmieding said could mean "a 2009 recession is a major risk," although his bank did not "quite believe" in such a scenario.

Meanwhile, ECB governors might also consider changes to collateral requirements linked to the bank's money market auctions, analysts said.

They could limit commercial banks' use of mortgage-backed securities for example, which "could be disastrous for distressed banks within, and possibly outside, the region," McKeown noted.

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