ECB predicts very gradual recovery

FRANKFURT - The European Central Bank kept interest rates unchanged at a record low of 1.0 percent on Thursday and President Jean-Claude Trichet said the euro zone economy faced a very gradual recovery from recession.

ECB staff also raised their estimates for euro zone GDP this year and next, while inflation estimates were edged higher.

However, Trichet stressed it was too early to end its exceptional measures to boost the euro zone economy, and announced the ECB would pump more one-year funds into the financial system at just 1 percent interest later this month.

There are increasing signs of stabilisation in economic activity in the euro area and elsewhere, he told a news conference.

This is consistent with the expectation that the significant contraction in economic activity has come to an end and is now followed by a period of stabilisation and very gradual recovery.

Data have surprised on the upside in recent weeks. Germany and France, the region's biggest economies, unexpectedly bounced out of recession in the second quarter. The overall euro zone economy shrank only 0.1 percent against the previous three months, following a 2.5 percent drop in January-March.

However, asked about how long the ECB would keep up its ultra-loose policy, Trichet said: Today is no time to exit.

New quarterly staff projections put gross domestic product growth in the 16-nation region at between -0.5 and +0.9 percent next year, giving a midpoint of +0.2 percent, compared with a range of -1.0 percent to +0.4 percent in the June forecast.

ECB staff also upgraded their projections for this year, and said they expected GDP to fall between 4.4 and 3.8 percent in 2009, a slightly smaller contraction than the 5.1 to 4.1 percent range given in June.
The ECB expected price stability to be maintained over the medium term, Trichet added.

All 80 economists polled by Reuters had forecast the decision to keep rates at their current all-time low for the fourth month running and markets were little moved by the decision.

It's absolutely no shock that both the refinancing rate and the deposit rates have been left on hold. Indeed previous talk about a possible reduction in the refi rate has all but disappeared given the signs of recovery through much of the euro area, said Investec economist Phillip Shaw.

Sweden also kept interest rates on hold earlier on Thursday.

The need for caution was underscored as ECB policymakers met. Euro zone retail sales fell unexpectedly in July, data revealed, a reminder that demand remains fragile at best.

TENDER INTEREST

Trichet confirmed the ECB would offer banks unlimited 12-month funds at a flat rate of 1.0 percent at an operation later this month, offering no sign of easing up on its unconventional measures to support the economy.

In late June, the ECB flooded markets with a record of 442 billion euros of one-year funds, which they are still digesting, in an effort to kickstart lending.

The ECB had previously said two other such operations, scheduled for September and December, could be at a higher rate. But Trichet said: This decision (...) should promote the extension of credit to the euro area economy and therefore further underpin its economy.
The worry is that the recovery's momentum will be lost once central banks and governments around the world begin to take away the emergency support measures built up during the crisis.

Economists have also raised doubts about the speed and sustainability of any recovery because of high and rising unemployment, which reached 9.5 percent in July -- the highest in more than 10 years.

Economists polled by Reuters expect unchanged ECB rates until the third quarter of next year and investors have eased back on their bets for early tightening.

(For a graph of world interest rates, please double-click on: here)

(Reporting by Marc Jones, additional reporting by Kirsten Donovan in London; editing by David Stamp)