ECB holds interest rates, slashes growth forecasts
FRANKFURT (AFP) — The European Central Bank kept its key lending rate unchanged on Thursday and slashed its growth forecasts for this year and next, sending stock markets and the euro into tailspins.
The ECB left its main interest rate at 4.25 percent, as widely expected, while cutting sharply its growth forecasts and raising inflation projections for 2008 and 2009.
European stock markets shed more than 2.0 percent and Europe's single currency sank to its lowest level since December 21, hitting 1.4326 dollars.
The central bank cut its 2008 growth forecast to 1.4 percent from 1.8 percent previously, and estimated growth next year at 1.2 percent, compared with its earlier outlook of 1.5 percent.
In Britain, the Bank of England kept its main lending rate steady at 5.0 percent, opting against a cut despite the growing threat of recession in Britain in order to sustain the fight against soaring inflation.
Aurelio Maccario, chief eurozone economist at UniCredit Markets, said the new growth forecasts meant the ECB was not expecting recent sharp falls in oil prices to bring much relief to the struggling eurozone economy.
"On the growth front, the ECB remains rightly cautious in buying too much from the recent oil drop," he said. "In (ECB president) Jean-Claude Trichet we saw an increased awareness that we are headed toward tough times."
Many eurozone countries would like lower interest rates, but a cut would undermine the ECB's primary goal of maintaining price stability -- as restated by ECB president Trichet on Thursday.
"Inflation rates are likely to remain well above levels consistent with price stability for a protracted period of time," he told a Frankfurt press conference.
The ECB chief also said its governing council had "no bias" with respect to future interest rate decisions, and that its "current monetary policy stance will contribute to our objective" of price stability.
Analysts take those phrases to mean the bank is now on hold for several months, at least.
Trichet nonetheless took note that the "euro area economy is currently experiencing an episode of weak activity," following a contraction in the second quarter, the 15-nation bloc's first such decline.
Another fall in the third quarter would technically put the eurozone in recession, but Trichet said that "after this trough that we are experiencing, we will have a progressive recovery."
Eurozone activity has been slowed by high commodity prices, the euro's strength against other currencies, slumping global demand and tighter credit conditions, but Natixis economist Sylvain Broyer noted that "the ECB excludes the risk of recession."
Trichet stressed that the ECB's "primary objective" was to maintain price stability, adding it was "imperative to avoid broad-based second-round effects in price and wage-setting."
The last reading for eurozone inflation was 3.8 percent, well above the ECB's target of just below 2.0 percent, and on Thursday the bank tweaked upwards its projections for this year and next.
Prices are now forecast to increase by 3.5 percent in 2008 from 3.4 percent previously, which analysts had expected, and by 2.6 percent next year, up from 2.4 percent, which they had not.
"The fact that the ECB raised its 2009 inflation call and expects inflation to fall into line with its target only over the course of 2010 indicates that the ECB would strongly resist calls for rate cuts," said Bank of America senior economist Holger Schmieding.
Trichet's warning on wages appeared directed in part towards the powerful German trade union IG Metall, which has called for pay hikes of at least seven percent.
Similar efforts have been seen in other eurozone members as workers try to bolster pay packets that have been eroded by rising costs for energy and food.
"The decisive factor is and will continue to be what happens to long-term inflation expectations," said Joerg Kramer, chief economist at Commerzbank, because the ECB is watching closely to see if excessive wage increases threaten to create a second round of inflationary pressure.
Finally, Trichet announced that the ECB would tighten certain lending conditions to banks, making it more expensive for them to offer risky assets as collateral in ECB operations that provide cash to keep credit markets running smoothly.
