ECB Holds Interest Rates; Trichet Sees Gradual Economic Recovery After Weakness

(RTTNews) - Battling high inflation in a sluggish economy, the European Central Bank left its interest rates unchanged at a seven-year high for the second straight month in September. The central bank chief said the Eurozone economy is in an episode of weak activity and expects a gradual recovery to follow.

Thursday, at the session held in Frankfurt, the Governing Council maintained the key-lending rate, which is the minimum bid rate on the main refinancing operations, at 4.25% in a widely expected move. The central bank had maintained the rate at a six-year high of 4% since June last year, before hiking it in July 2008. The interest rate on the marginal lending facility was held at 5.25%, while the interest rate on the deposit facility was retained at 3.25%.

In August, the ECB had kept its key interest rate on hold after hiking 25 basis points in July to 4.25% amid high inflation and slowing growth in the Eurozone. The central bank chief Jean-Claude Trichet had then signaled that there are no more hikes in store in the near term.

The Eurozone annual inflation eased to 3.8% in August from a record 4% in July. Annual inflation continues to stay above the ECB target, which is to keep inflation rates “below, but close to, 2% over the medium term”. According to economists, the ECB would possibly resist pressures to slash interest rates as long as inflationary pressures remain strong.

Another price level indicator, the producer price index rose 9% year-on-year in July, marking the highest annual rate since the series began in 1990 and faster than the 8% increase in June.

Driven by factors including deteriorating external environment and surge in oil and food prices, the Eurozone economy contracted in the second quarter for the first time since the launch of Euro nearly a decade ago.

In a latest report the Eurostat said the 15-nation economy contracted 0.2% quarter-on-quarter in the second quarter, reversing a 0.7% expansion in the first quarter. This was also the first contraction since records began in 1995. At the same time, the statistical office revised the annual growth rate for the second quarter to 1.4% from the preliminary estimate of 1.5%. This follows a 2.1% increase in the first quarter.

At the post-meeting press conference, Trichet said upside risks to price stability prevail in Eurozone, and that medium-term price stability remains the priority for the apex bank. He also noted that policymakers are not in a hurry to cut rates.

Regarding economic growth, the central bank chief said recent data confirms the weakening of GDP growth in 2008, but, a gradual recovery is expected following the weak episode. The ECB slashed its 2008 economic growth forecast to about 1.4% from 1.8% and its 2009 outlook to 1.2% from 1.5%. The central bank hiked the inflation forecast for 2008 to 3.5% from 3.4% and the prediction for next year to 2.6% from 2.4%.

Trichet reiterated his concern over wage growth, saying policymakers will watch this with “particular attention.” He maintained that risks to price stability remains on the upside and that the current level of interest rates will help achieve the ECB’s mandate of price stability.

Further, Trichet noted that the level of inflation is “worrying” and wage growth is picking up in recent months. The rate-setting committee believes it is imperative to avoid broad second round effects.

On the other hand, recent data has laid bare growing weakness in different sectors of the economy. In the second quarter, household consumption, a major growth driver in Eurozone, declined 0.2% quarter-on-quarter after recording zero growth in the previous quarter.

The Ifo economic climate indicator for the Eurozone slumped to its lowest level in 15 years in the third quarter as pessimistic assessment on the current economic situation and the outlook for the coming six months increased.

The latest survey conducted by the European Commission showed that the Eurozone economic sentiment index deteriorated, though consumer and services sector confidence measures rose slightly services. However, mounting inflationary pressures continued to impact sentiment in the economy.

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