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ECB expected to hold interest rates

Thursday, October 04 07:25:26

ECB Executive Board member Benoit Coeure said last week that economic and inflation data did not justify an October cut - a view echoed by Austria's central bank governor Ewald Nowotny. Wednesday's purchasing managers indexes (PMIs) showed companies faced dwindling orders and faster layoffs. But consumer prices rose at an annual rate of 2.7 percent in September, the 22nd month that inflation has been above the ECB's target of just below 2 percent, limiting its room to act. The ECB has also said its record-low interest rates are not filtering through to households and companies, especially in troubled southern Europe where lending rates are much higher. It hopes the new bond programme will reduce borrowing costs.

A small majority in the Reuters poll expect the ECB to cut the refinancing rate to 0.5 percent by the year end, however, so economists will be eager to see if Draghi drops any hints. That would also raise questions about a deposit rate cut. It stands at zero so that would take it into negative territory. The ECB would then effectively charge banks to hold their money overnight but some policymakers, including Nowotny, say this would create problems. "We have already seen quite a lot of decisions outside the box, yet another measure outside the box before we have seen any implementation of what is already on the table might create more confusion than benefit for the market," G+ Economics' Lena Komileva said.

The ECB said last month it would buy short-term debt of struggling euro zone countries such as Spain in return for commitments to reform. The news calmed financial markets but investors are keen to see how the programme works in practice. Draghi has stressed that it is up to governments to take decisive action, but he will nonetheless be quizzed on his assessment of the current negotiations on Spain. He has to stick to his promise to help the euro zone despite criticism from the German Bundesbank which says the new programme is close to breaking the rule banning the ECB from financing governments.

"Given that the ECB's actions are hostage to the political debate, in particular the EU/Spain dialogue on Spain's request for EFSF aid, some news that Mr. Draghi himself is encouraged by developments will go a very long way to provide support to the market," said G+ Economics' Komileva. ( C) Reuters