The European Central Bank is set to hold interest rates at a record low level of 1.0 percent on Thursday and detail the next steps in its gradual withdrawal from emergency lending.
With Greece's debt troubles unresolved and concerns growing about the fragility of Europe's recovery, the monthly meeting is also expected to adopt a cautious tone on the economy and keep staff forecasts for growth and inflation largely unchanged.
The 87 economists polled by Reuters were unanimous this month in seeing no change in rates and on average expected the first rise only in the fourth quarter. [ECB/INT] Money markets expect no increases until well into next year.
Instead of the 1245 GMT rate decision, Thursday's focus will be on what changes the ECB plans to make to the extra liquidity it has provided for the banking system since the worst days of the financial crisis in 2008, with markets primed for some minimal tightening of conditions — most likely in access to 3- and 6-month money. [ID:nLAG006122] <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For graph on ECB interest rate increase expectations: http://r.reuters.com/xyt42j For graph of ECB lending to banks: http://graphics.thomsonreuters.com/0210/EZ_ECBLEN0210.gif ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
In the Governing Council meeting, now under way, the 16-country bloc's central bank could switch back to auctions for its 3-month operations, shortening outstanding maturities as commercial banks take more money in flat-rate weekly operations.
This would make it easier for the bank to reduce excess liquidity as it gradually normalises financing conditions and starts to push up the overnight interest rates towards the main refinancing rate.
In the back of policymakers' minds, however, is the fact that banks must repay a massive 442 billion euros ($603 billion) of 12-month ECB loans at the start of July.
Added to expectations for weak growth in the first quarter and worries about Greek debt, that means the ECB is very likely to keep spooning out unlimited funds at fixed rates in its weekly liquidity operations through the second quarter.
"While there is a clear desire to return to normality and regain control of the interest rate instrument, tensions surrounding Greece and the banks in general are likely to inject some concern that a too fast exit could be dangerous," Goldman Sachs economist Erik Nielsen said in a note.
"One week operations … will be left as fixed-rate full-allotment operations."
Governing Council member Axel Weber buoyed expectations this month that the last six-month operation would be indexed to its main refinancing rate, though he said returning all maturities to tender procedures would not happen at once. [ID:nLAG006110]
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ECB staff projections for growth and inflation, to be released at Thursday's news conference starting at 1330 GMT, are closely followed.
In December, it forecast growth of about 0.8 percent this year and 1.2 percent in 2011, while inflation was seen at about 1.3 percent this year and 1.4 percent in 2011.
While many economists said in December the ECB's outlook was pessimistic, recent data has endorsed its caution, and European Commission forecasts released last week were similar.
"I would expect very little change from December or (ECB President Jean-Claude) Trichet's message from February," said BNP Paribas economist Ken Wattret. "I think the news has reinforced the ECB's view rather than challenged it."
However, others argue that the sharp trade-weighted drop in the euro <EUREER=ECBF> since the last set of forecasts could lift both growth and inflation numbers for next year.
Finally, Trichet's message on Greece will be closely followed. The ECB said late on Wednesday it welcomed the latest austerity steps announced by Greece and appreciated Athens' plans to implement them swiftly. [ID:nLDE6222JN]
Markets are looking for signals whether the ECB would postpone a return to tighter collateral rules for the money it lends to banks, due to fears that Greek government debt would be excluded next year if Moody's cut its credit rating to levels similar to Fitch and Standard & Poor's.
"The ECB is hoping to avoid having to do anything," said BNP Paribas' Wattret. "However, that may not be feasible … they will cross that bridge when they have to."
