ECB keeps interest rate at record low, but upgrades 2010 GDP forecast

The European Central Bank (ECB) held interest rates at a record low of 1.00 percent, as expected, and also extended its liquidity measures through the end of 2010 in response to an uneven recovery in the euro zone as well as continuing fears about the viability of some banks.

ECB president Jean-Claude Trichet stated that interest rates are at an “appropriate” level. He also revealed that the decision for unchanged interest rates was "unanimous" and that the Bank's Governing Council “has no intention to signal any change in the present interest rates."

The ECB also upgraded its GDP forecast for the euro zone to a range of 1.4-to-1.8 per cent this year from its previous forecast of 0.7-to-1.3 percent, citing an unexpectedly strong second-quarter performance on the continent.

However, Trichet cautioned that the recovery will occur "at a moderate pace with uncertainty still prevailing."

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For 2011, the ECB forecasts growth to range between 0.5-and-2.3 per cent – up slightly from its previous 0.2-to-2.2 percent expectation.

“The ECB continues to give the impression that interest rates are going nowhere for some considerable time to come,” said Howard Archer, IHS Global Insight's chief European/U.K. economist.

“These decisions were widely expected given the uneven euro zone economic recovery and the still high dependence on ECB funding by banks in the more vulnerable euro zone countries, notably Greece, Spain and Ireland.”

Jonathan Loynes, chief European economist at Capital Economics, said that while the ECB struck a slightly more upbeat tone towards the economy at its press conference, it nonetheless maintained its support for the region’s banking sector and remains a long way from implementing any form of conventional policy tightening.

“Despite this more positive tone, however, the ECB continued to stress the risks surrounding its central forecasts, which were seen as tilted towards the downside,” he said.

Moreover, Loynes indicated, the central bank stressed that any euro-zone countries enjoying stronger than anticipated growth should respond by making faster progress towards fiscal consolidation.

Archer pointed out that the ECB continues to stress that all of the non-standard measures that it is taking - enhanced credit support and the Securities Markets Program - are fully consistent with the bank's mandate to maintain euro zone price stability over the medium term and are temporary in nature.

“The ECB continues to be relatively cautious about euro zone growth prospects, noting that the second quarter jump in GDP growth to 1.0 percent quarter-on-quarter was partly lifted by temporary domestic factors,” he added.

Meanwhile, the ECB remains sanguine about euro zone inflation.

“While the bank believes that euro zone consumer price inflation may rise slightly from the August level of 1.6 percent in the latter months of 2010, it sees inflation remaining 'moderate overall' in 2011 due to low domestic price pressures,” Archer noted.

“The ECB stressed that it sees medium and longer-term inflation expectations firmly anchored in line with the ECB's inflation target of 'below, but close to, 2 percent' over the medium term'"

Archer said he believes that the central bank will keep rates where they are very deep into 2011, citing that the ECB is very aware that the euro zone's economy will be buffeted over the coming months by tighter fiscal policy increasingly kicking in across the region and likely slower global growth.

“Furthermore, sovereign debt problems in the euro zone could well flare up again,” he added.

“Meanwhile, there seems good reason to expect underlying inflationary pressures to remain muted in the euro zone given overall gradual recovery, significant excess capacity and muted wage growth.”