ECB holds rates at 1% as recovery looks shaky

Written by Bloomberg | Frankfurt | Updated: Apr 5 2012, 06:45am hrs
The European Central Bank held interest rates at a record low of 1% on Wednesday and is expected to resist German pressure to flag an exit from its crisis-fighting mode as the euro zone recovery looks increasingly shaky and concerns grow about Spain.

Germany's powerful Bundesbank has led a push by central bankers from the euro zone's core for the ECB to begin preparing an exit from crisis measures that have seen it loosen the rules for tapping ECB funding operations.

Attention will now shift to ECB President Mario Draghi's 1230 GMT news conference for any indications on whether the central bank is bending to the German-led pressure - an unlikely scenario as the euro zone economy remains in a fragile state.

Commerzbank economist Michael Schubert said the ECB's decision to hold its main interest rate at 1% was no surprise. Persistently high inflation and an economy flirting with recession are effectively cancel each other out.

After cutting interest rates only a few months ago, the ECB is now in wait-and-see mode, also to assess the impact of the three-year loans, Schubert said. It will take several months until this shows up in lending to the real economy.

The ECB has pumped over 1 trillion euros into the financial system with twin 3-year funding operations, or LTROs, to head off a credit crunch that late last year risked exacerbating the euro zone crisis and jeopardising the currency project. The German-led group of policymakers is concerned that the wave of cash risks stoking inflation pressures.

Euro zone inflation eased to 2.6% in March - above the ECB target of just below 2%and higher than expected - but the renewed worries about Spain mean the ECB cannot afford to signal a rate rise or an exit from the funding measures. I think the situation is far too fragile for the ECB to meddle in exit strategies at the moment, especially if you look at Spain, said Berenberg Bank's Christian Schulz, a former ECB economist. It's clear the downtrend in yields on sovereign bonds was triggered by the LTROs. If the ECB were to say 'well, actually now we're thinking about exiting this strategy', that would cause concern over whether these low interest rates are sustainable.