ECB Keeps Interest Rates The Same: 1.0%

The European Central Bank held interest rates at 1.0 percent for the third month running on Thursday, pausing to assess the impact of a dramatic sweep of measures that has unsettled some at the bank.

Attention will now shift to ECB President Mario Draghi's 1.30 p.m British time news conference, at which he will present updated ECB economic forecasts that financial markets will scrutinise for hints about whether a recent 20 percent rise in oil prices is rekindling inflation concerns.

Draghi is likely to put the onus on governments to fight the euro zone crisis after the central bank pumped over 1 trillion euros (839 billion pounds) into the euro zone banking system since December with twin three-year funding operations, known as LTROs.

The ECB also cut rates twice late last year to a record low of 1.0 percent. Thursday's decision to hold the main refinancing rate at that level was in line with expectations.

Financial markets showed little response to the decision, with the euro and benchmark German bund futures unmoved, down 32 ticks on the day.

We are now keen to see the staff projections, said Citigroup economist Juergen Michels.

We expect only slight downward changes to the growth forecasts and a slight upward revision to the inflation forecasts, mostly on the back of the movement in oil prices.

The latest Reuters poll of 74 economists suggests the ECB will hold rates at 1.0 percent until well into 2013.

The euro zone economy has stabilised over recent months, in part thanks to the ECB's back-to-back rate cuts in November and December and the twin funding operations, which brought calm to euro zone debt markets.

But that is likely to be the extent of the ECB's policy response to the euro zone crisis, which has been a drag on economic growth in the region and the broader global economy.

Draghi, who faces unease among his fellow Council members about the risks the ECB has taken on with the funding operations, told EU leaders last week it was now up to them to revive growth by implementing reforms.

In terms of tone, I expect Draghi to say: A lot of money has been put out there now, let's see it be put to work, said Erik Nielsen, global chief economist at Unicredit.

FORECASTS

Financial markets will scour the ECB's latest staff projections for changes in forecasts for growth and inflation.

Inflation has come off last year's peak of 3 percent as growth in the crisis-stricken euro zone has slowed, but it climbed again last month, remaining above the ECB's inflation target of just below 2 percent for the 14th month in a row.

Forecasts for 2012 and 2013 inflation could be raised from the respective midpoint estimates of 2.0 and 1.5 percent in the last round.

The inflation projections are likely to be revised up for this year and next due to the increase in oil prices, said RBS economist Nick Matthews.

Overall, we expect the ECB to continue to recognise that uncertainty remains high and for the Council to leave its options open with regards to possible further refi rate cuts.

Growth expectations are likely to be cut. France, Europe's second largest economy, is set for flat economic growth in the first quarter, the country's central bank said on Thursday.

December's ECB projections showed euro zone gross domestic product in a -0.4 percent to +1.0 range this year - optimistic compared with the latest Reuters poll consensus for a 0.4 percent decline.

The ECB is likely to signal that it expects a gradual stabilisation of economic conditions to continue, said Nordea economist Anders Matzen. It's quite clear that the LTROs have substantially removed the downside risk to the economic outlook for the euro zone.

DIRTY LAUNDRY

The ECB earned widespread praise for averting a euro zone credit crunch with its three-year loans - handing out 489 billion euros in December and 530 billion euros in February - and by loosening the rules for collateral banks can use in exchange for central bank money.

However, some policymakers are worried.

Bundesbank President Jens Weidmann aired his concerns in a letter to Draghi last month. Juergen Stark, the ECB's influential former head of economics, added his criticism by telling a German newspaper on Thursday that the quality of the central bank's balance sheet was now shocking.

While Draghi is likely to be asked about the issue, Unicredit's Nielsen expects a tight lipped response.

Draghi is not going to take the Governing Council's laundry into public, he said.

In his letter, which was leaked to the conservative German newspaper Frankfurter Allgemeine Zeitung on the day of the ECB's second dose of three-year funds, Weidmann wrote about the imbalances in the euro zone's payment system, TARGET2, and the resulting risks for the Bundesbank, which would be exposed in the unlikely event of the euro zone breaking up.

Draghi has played down those concerns.

Another issue which may need explaining is the ECB's decision to swap its Greek bonds to avoid taking losses and thereby breaking the taboo of directly financing governments as Greece's debt restructuring comes to a head.

Greece's private creditors must decide by Thursday evening whether they take part in the debt swap that is a key part of Greece's new 130 billion euros bailout package. Failure to secure the deal may put the rescue package at risk and open up the threat of a chaotic debt default of Greece.

That, unlikely as it now looks, would force the ECB firmly back into crisis-fighting mode.