ECB to hold rates steady amid market calm

The European Central Bank is set to keep interest rates on hold next week as it takes stock of the newfound calm on the financial markets, analysts predict.

"The continued improvement in financial market conditions and surveys of economic activity has taken some of the pressure off the ECB this month," said Capital Economics economist Jennifer McKeown.

"We expect the bank to strike a relatively hawkish tone after its forthcoming meeting, stating that no further policies are needed at present," she said.

With ECB interest rates currently at a record low of 0.75 percent and its latest anti-crisis weapon ready and primed for action, central bank chief Mario Draghi believes the bank has already done its utmost and it is up to governments to resolve the long-running crisis, economists said.

"Draghi will again call on politicians to use the calm on the financial markets for structural reforms," suggested Commerzbank economic Michael Schubert.

"We do not expect any further measures from the ECB."

Evidence appears to suggest that the eurozone could finally be emerging from its three-year-old sovereign debt crisis with confidence indicators all across the single currency area pointing upwards.

Last week, the clouds of economic gloom lifted when the EU's eurozone confidence index rose markedly for the third month running.

And Germany, the region's biggest economy, appears to be unflappable, with investor, business and consumer confidence all on the rise and unemployment close to historic lows.

Experts and analysts attribute much of the calm to the ECB's own anti-crisis measures, which have spanned a safety net under the single currency area's most vulnerable countries.

In addition to slashing interest rates, the bank set up a scheme to buy up the sovereign bonds of debt-wracked nations and also pumped an unprecedented 1.0 trillion euros ($1.3 trillion) of liquidity into the banking system via ultra-cheap three-year loans, known as LTROs.

An indication of just how successful the LTROs have been came last week when the ECB announced that many banks are already starting to repay some emergency loans ahead of time.

ECB watchers see that as a sign that banks are enjoying better access to funding.

But McKeown at Capital Economics warned that the LTRO data were not necessarily all good news.

"Announcements made so far suggest that repayments have been made almost exclusively by strong banks in the region's core as they have sought to prove their financial health to outsiders," she said.

"But banks in the periphery remain reliant on ECB funding and repayment by others is only highlighting their problems and risks further intensifying the fragmentation in the sector," the expert warned.

McKeown also suggested that the fact that banks were choosing to repay the loans was because demand for credit by both households and firms remains weak and the banks are struggling to find profitable ways to use the money.

That is backed up by the ECB's own latest data which showed that eurozone bank loans to the private sector declined by 0.7 percent in December, after already shrinking by 0.8 percent in November.

The decline comes despite an improvement in banks' own access to funding.

Economists point out that the positive mood on the markets is currently all coming from forward-looking sentiment indicators and has yet to translate into an improvement in hard data.

"It is clear that the improvement in financial markets is not yet being felt in the wider economy," McKeown said.

UniCredit economist Marco Valli agreed.

Draghi would thus "most likely stick to his cautious tone on the real economy," said Valli.

The euro's recent rise against the dollar -- to its highest levels since November 2011 -- could also turn into a headache in the longer run, as it could prove a drag on the region's exports, analysts warn.

UniCredit's Valli said the ECB's governing council meeting on Thursday would therefore be "an interesting one."

While he was "virtually certain that rates will be left unchanged... Draghi's tone on improving sentiment, the stronger euro as well as the larger-than-expected early LTRO repayments should deserve close monitoring," he said.

--

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