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ECB rates seen stuck at 1 percent for another year

Source: Reuters - Fri 7th Aug 2009

Euro zone interest rates will likely stay at a record low for at least another year as the prospect of solid growth remains distant and deflation fears persist, a Reuters poll found.

While small sparks of a recovery may be seen, the euro zone economy will not return to strong growth for some time and will need the low rates and to some extent the extra stimulus measures that the ECB has provided well into 2010.

All 75 economists in a survey said the European Central Bank's Governing Council would leave rates at their record low of 1.0 percent when it meets in Frankfurt on August 6.

Policymakers have consistently said that level remains "appropriate" for now. Economists agreed, saying the ECB will not look to tighten policy until the fourth quarter of 2010.

By then rates would have been at a low of 1.0 percent for around a year and a half to fight a severe recession, which would be the longest period that rates were kept on hold in the ECB's 10-year history.

"The economy is hopefully heading towards recovery but we are not likely to see growth until next year so rates will be on hold for some time yet" said Robert Barrie at Credit Suisse.

The bank has thrown much more at a recession-struck economy than just low rates, pumping billions of euros into money markets as it tries to stimulate lending, and kicking off its own version of quantitative easing buying up covered bonds.

The economy has shown tentative signs of edging back to growth by the end of the year, according to recent survey data such as Germany's Ifo and the euro zone PMIs, though any expansion would be meagre. 

But economists do not expect any ECB retreat from such ultra-loose monetary policies for some time yet.

Last week ECB Executive Board member Jose Manuel Gonzalez-Paramo said the bank would not think about raising rates again until the risk of deflation had fully faded.

"We believe interest rates are currently appropriate ... monetary policy will change when the risk to price stability starts to lessen and this has still not happened."

Economists continue to fret over the prospect of deflation, a sustained and widespread fall in prices, despite none of them actually forecasting it in Reuters surveys.

Official inflation for July is forecast to slip further into negative territory when data is released on Friday, but is expected to climb towards the end of the year, albeit well under the ECB's 2.0 percent target ceiling.

Any exit strategy looks for now some way off despite debate heating up as to how the bank will manage it. Governing Council member Ewald Nowotny recently said that once the economy improved its first step would be to drain liquidity, and secondly to consider its rate policy.

But the improvement in the economy is key. The economy contracted by 2.5 percent in the first quarter, and is not forecast to grow again until the last three months of the year, and then by just 0.1 percent.

"The uneven path to economic recovery and risk of further near-term and medium-term disappointment over GDP means that we do not expect the ECB to be in any rush to reverse the monetary cycle" said Kenneth Broux at Lloyds TSB.

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