(RTTNews) - Thursday, the European Central Bank President Jean-Claude Trichet gave a strong indication that the central bank is preparing to rollback unconventional measures to mop up excess liquidity from the Eurozone economy.

“Looking ahead, and taking into account the improved conditions in financial markets, not all our liquidity measures will be needed to the same extent as in the past,” Trichet said in his introductory statement after the ECB Governing Council retained its key interest rate at a record low of 1% for a sixth straight month. “The current rates remain appropriate,” he reiterated.

As global economic conditions have started moving to a pre-crisis level, central banks are preparing to wind up their emergency measures.

In October, Australia became the first among G-20 nations to hike interest rates since the onset of the financial crisis in late 2008. The Reserve Bank of Australia raised its key interest rate for the second straight month on November 3. On October 27, India’s central bank ended some of its liquidity support measures, signaling the start of its exit strategy. A day after, Norway’s central bank became the first in Europe to raise key interest rates as economies in the region show signs of emerging from the financial crisis.

Trichet said the Governing Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion. The bank will also ensure that the liquidity provided is absorbed in order to counter effectively any threat to price stability over the medium to longer term. “The bank is clearing the way for withdrawing some of its extraordinary liquidity support measures,” IHS Global Insight Chief UK and Eurozone Economist Howard Archer said.

The ECB’s rate-setting body is likely to take a decision in December on ECB’s programme of offering 12-month money to banks at just 1%, Trichet said. Banks drew EUR 75 billion at the last offering in September, down from EUR 442 billion in the first tender in June, suggesting that market conditions are improving.

The central bank chief refused to “dispel” a market view that the scheme would not be extended beyond December. Further, he declined to indicate whether or not the ECB would apply a spread to December’s operation. “The ECB will opt for the gentle backdoor exit for its non-standard measures, not for an active withdrawal of liquidity, by not extending these 12-months operations in December,” ING economist Carsten Brzeski said.

“We still expect shorter auctions with full allotment in 2010,” Danske Bank Senior Economist Frank �land Hansen said. “As a minimum we expect the one-week actions with full allotment to continue.”

Regarding the economy, Trichet said the latest information continues to signal an improvement in economic activity in the second half of this year. The Governing Council expects the euro area economy to recover at a gradual pace in 2010, although the outlook remains subject to high uncertainty. According to economists, the 16-nation economy probably exited recession in the third quarter.

In December, the central bank is due to present its new growth and inflation projections. “We think they ought to revise their growth estimate for 2010 a full two percentage points upward to get it right, but it is unlikely to revise it up by much more than half a percentage point,” the Danske Bank economist said.

Economists are not looking for an immediate rate hike in December. “The ECB’s economic outlook is still too
sombre and its inflation outlook too benign to call for any pre-emptive rate hikes”, Brzeski said. The ING economist pointed out that even a gentle exit of the non-standard measures does not mean that rate hikes will follow automatically. “The December meeting will be crucial to understand future ECB’s actions,” BNP Paribas economist Clemente De Lucia said.

Moreover, Trichet said medium to longer-term inflation expectations remain firmly anchored in line with the Governing Council’s aim of keeping inflation rates below, but close to, 2% over the medium term. In the coming months, annual inflation rates are projected to turn positive again and risks to this outlook is broadly balanced.

Consumer prices declined on an annual basis for a fifth month in October. Citing inflation expectations based on the Survey of Professional Forecasters that are noticeably lower, Commerzbank analyst Michael Schubert said it is not inflation expectations but rather inflation uncertainty that has risen.

With regard to fiscal policies, Trichet said many euro area governments are faced with high and sharply rising fiscal imbalances. He warned that if not addressed by a clear and credible exit strategy, this could seriously risk undermining public confidence in the sustainability of public finances and the economic recovery.

Therefore, the Governing Council called upon governments to communicate and implement in a timely fashion ambitious fiscal exit and consolidation strategies based on realistic growth assumptions, with a strong focus on expenditure reforms. “Tax cuts should only be considered over the medium term, when countries have regained sufficient room for budgetary manoeuvre,” Trichet urged.

As the ongoing improvement in financing conditions is likely to boost demand for credit in the period ahead, Trichet asked banks to take appropriate measures to strengthen their capital bases. He also said banks can take full advantage of government measures to support the financial sector, particularly as regards recapitalization. On the exchange rate, Trichet reiterated his references to the strong dollar.

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