The European Central Bank held interest rates at a record low on Thursday and is expected to keep its liquidity safety-net for banks in place as well amid a lopsided recovery and worries about vulnerable banks.

All 78 economists in a Reuters poll predicted the ECB would leave rates at 1 percent for the 16th month in a row and the median expectation is for no change until the fourth quarter of 2011.

Analysts also expect the ECB's 22-member Governing Council to keep lending banks unlimited funds until early next year, maintaining the lifeline relied on by banks in countries like Spain, Ireland and Greece.

Borrowing from the ECB by banks in these countries has hit record highs in recent months even though total lending has fallen about a third since July, highlighting the difficulties still faced by some institutions.

Ratings agency Standard & Poor's cut Ireland's credit rating last week to AA- on the back of an upward revision to the country's banking crisis bill.

The 10-year Irish/German government bond yield spread has hit record highs and spreads on other peripheral government bonds have also jumped over the last month amid growing evidence of a split between core euro countries and those on the periphery.

Germany grew at its fastest rate since reunification in the second quarter and more than twice as fast as the euro zone average, confirmed at 1.0 percent on Thursday. Greece is still in recession and Portugal and Spain managed just a tenth of Germany's growth rate.

Analysts said the fragile situation in markets and the uneven recovery meant the ECB, like other central banks, would have to tread carefully in pulling back support measures.

ECB President Jean-Claude Trichet will announce the decision on liquidity supply at his 1:30 p.m. British time news conference but most see an extension as a done deal given even German arch-hawk Axel Weber said it would be wise to keep borrowing uncapped.

We expect that at this stage the ECB will choose the path of containing systemic risk in the banking system by providing unlimited cheap leverage beyond the year-end rather than by looking to lift the value of bank assets through direct market interventions, Tullett Prebon economist Lena Komileva said.

GROWTH UPGRADE

ECB staff are expected to upgrade growth forecasts on Thursday but analysts said this reflected the strong German showing in Q2 and was no all-clear for the future.

The hopes the ECB may have had that the (bank) stress tests would restore confidence are now evaporating, RBS economist Jacques Cailloux said.

The renewed weakness that we are getting in key export markets is probably feeding into concerns that we are facing weakness on the economic front.

Most economists in the Reuters poll expect growth for 2010 to be revised up from June's mid-point of 1 percent but for the outlook for 2011 to remain around 1.2 percent.

Inflation is seen below the ECB's 2 percent ceiling, with most economists expecting staff forecasts to remain around 1.5 percent for 2010 and 1.6 percent for 2011.

Euro zone inflation moderated to 1.6 percent last month from 1.7 percent in July according to Eurostat's preliminary reading.

Still, there are some signs of pressure, notably Germany's powerful steelworkers union demanding a 6 percent pay rise.

NOT ALONE

Expectations of continued ECB liquidity largesse have pushed market interest rates down from 12-month highs over the last month, although pressure points remain.

Turnover in overnight money markets fell back in August after doubling in July to more than 1 trillion euros and many banks still prefer to deposit excess funds back at the ECB rather than lending them on to counterparts.

Banks also face a liquidity cliff at the end of September when they must repay a total of 225 billion euros in 12-, six- and three-month funds or roll it into shorter maturities.

The ECB is not alone in dragging its feet towards the exit. Although Sweden's Riksbank hiked rates on Thursday to 0.75 percent, it cited weak growth in the euro zone and United States as a risk to the outlook. The Bank of Japan has boosted its cheap loan scheme and the U.S. Federal Reserve took steps towards further stimulus by reinvesting maturing mortgage-related securities.

(Editing by Mike Peacock)

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