ECB holds rates at 1 percent, sees downturn slowing

The European Central Bank kept interest rates on hold at a record low on Thursday and said the euro zone economy would remain weak over the rest of the year, although the rate of contraction is slowing down.

ECB President Jean-Claude Trichet said rates remained appropriate at the current level of 1.0 percent, adding that a fall in consumer prices in the euro zone's recession-bound economy was temporary.

He also said the ECB had no intention of scaling back its plan to buy 60 billion euros in covered bonds -- one of its unconventional policies to revive growth by lowering long-term interest rates -- despite a fairly slow start.

The euro zone's gross domestic product plunged 2.5 percent in the first quarter and Trichet's comments are in line with expectations that the ECB will keep rates at a record low until the end of the third quarter of next year.

Current rates remain appropriate, Trichet told reporters at his monthly news conference. Economic activity over the remainder of this year is likely to remain weak, although the pace of contraction is clearly slowing down.

The ECB has cut interest rates by 325 basis points since October, but they remain the highest among the biggest developed economies. The Bank of England, which also met on Thursday, left rates at 0.5 percent but raised its bond purchases to tackle the UK recession by 50 billion pounds. [nL6430949]

For a graph of world interest rates, please double-click on: http://graphics.thomsonreuters.com/RNGS/ECO/RATES.jpg

Euro zone consumer prices have started to fall but Trichet again expressed confidence that the bloc would not suffer broad deflation.

We expect the current episode of extremely low or negative inflation rates to be short-lived and price stability to be maintained over the medium term, he said. Referring to 2010, he added: After a phase of stabilization a gradual recovery with positive quarterly growth rates is expected.

Massive supplies of ECB liquidity have pushed short-term bank-to-bank rates well below the main policy rate.

NO PLANNED CUTS

Trichet played down the chance of reducing the bond purchases. There is no intention at all to change our decision to go up to the 60 billion, he told a news conference.

The ECB has said it would buy euro-denominated covered bonds -- debt backed by a pool of assets such as mortgage loans that remain on the issuing bank's balance sheet -- directly from primary and secondary markets over 12 months.

The program ... has been very successful, Vice President Lucas Papademos told the news conference. Activity in the secondary market has not increased as much as we would have liked, but I expect this will be the case.

Asked whether the full 60 billion might not be purchased, Papademos said: The program is expected to be implemented the way the Governing Council has announced, so what you refer to is speculation.

The amount of covered bonds bought by the ECB and national central banks has moved at a gradual pace and was around 5 billion euro at the end of July.

(Reporting by Krista Hughes; editing by David Stamp and Patrick Graham)