The European Central Bank will face scrutiny on Thursday over a spike in market interest rates, its plans to tackle banks' addiction to ECB funds, and any response to a growing global battle over currencies.
All 79 economists in a Reuters poll predicted the ECB would leave interest rates at a record low of 1.0 percent for the 17th month in a row, and the median forecast is for no change until the fourth quarter of next year.
Journalists will grill ECB President Jean-Claude Trichet about foreign exchange rates at a monthly news conference that precedes meetings of G7 financial leaders on Friday and a broader International Monetary Fund gathering in Washington.
The ECB and European governments have shown little sign of talk or action to cap recent gains for the euro, in contrast to policies in Japan, China and the United States which have led to warnings of a "currency war" in competitive devaluations.
The ECB is trying to balance efforts to withdraw the emergency support it has given to banks — which it has effectively put on hold until the turn of the year — with concerns of an autumn dip for the economy.
In the last month, banks have demanded much less cash at unlimited liquidity operations, suggesting more banks are able to access markets for funding and stirring speculation the ECB might roll back support sooner rather than later in 2011.
The 80-billion euro drop in excess cash in the system has pushed money market interest rates up to their highest in 14 months.
September 2011 Euribor futures show a 7 basis point rise in rate expectations since Sept. 24, which would take three-month rates almost 23 basis points above the ECB's benchmark rate.
Trichet is likely to repeat comments he made last week in Brussels that policymakers have taken note of the recent rise in market funding costs, but may refrain from endorsing it.
"The ECB will say this is up to banks, that's not a policy signal, that's up to banks' own behaviour," BNP Paribas economist Ken Wattret said. "If the ECB says it is welcome, it gives the impression it is actively pushing for higher interest rates."
STRONG EURO
The euro-zone recovery has been uneven, with several economies lagging the core countries, and many face weak growth prospects as well as a mountain of debt, with the cost of servicing it at record-high levels.
Banks in Ireland, Portugal, Greece and Spain have taken the lion's share of ECB funding. More than half of outstanding ECB liquidity was from those countries despite them amounting to less than one-fifth of the euro-zone economy.
The stronger euro, now at an eight-month high against the dollar, does not make their plight any easier. It is up almost 18 percent against the dollar since hitting a four-year low in June and has gained 9 percent since the September rate meeting.
Trichet brushed off questions about the euro last week, and analysts said this may only change if it moves even higher.
"Given the central bank's misgivings about the medium-term implications of unconventional policy, it would take a large currency move and much weaker growth data for the ECB to respond," JP Morgan economist Greg Fuzesi said in a note.
With tighter money market conditions, the ECB is going in a different direction from other major central banks and analysts expect the rift to add to pressure on the euro to appreciate.
But the bank did last month extend its unlimited lending policy until at least January and the 22-member Governing Council is not expected to make any formal decisions on exiting these measures before December.
Analysts say there is a split forming within the Council between those wanting to push banks off the liquidity drip and those who think the support should stay as long as needed.
"Clearly there are some who are very keen to move to the next stage of the exit strategy," Wattret said, adding that others see a need for keeping measures in place.
"The contrast between those two camps is likely to become more rather than less pronounced."
Central bank insiders have said options being circulated to tackle bank addiction to ECB funds include tighter collateral rules and borrowing limits.
The ECB is not expected to make changes to its economic evaluation only a month after it put out the latest set of staff forecasts, and is seen continuing to expect moderate and uneven growth in the euro zone and repeat growth risks are slightly to the downside.
It is likely, however, to tweak the monetary analysis to a slightly more upbeat direction after August money supply data came in surprisingly strong and private sector lending hit a 14-month high.
ECB Executive Board member Juergen Stark called this likely a turning point to positive credit growth and markets want to know whether the Council as a whole shares his optimism.
"We have had a good month but (I'd like to know) how sure are they that it is definitely the turning point," said Danske Bank economist Frank Oland Hansen.
