---- by Steve Whitehouse ----
PARIS (AFX) - The European Central Bank will leave interest rates unchanged at today's governing council meeting, the council's last gathering before it takes a four-week summer break, but weakening economic growth could well push council members to cut rates when they return on Aug 30, economists said.
There has been no change in the ECB's message, and no major shift in the economic data, since ECB president Wim Duisenberg's July 5 comment that rates were appropriate "for some time to come", they said.
It is therefore difficult to see how the council would explain a rate cut at this week's meeting, which is being held by teleconference, they said.
"We do think there will be a discussion about it, but there hasn't really been the preparatory work and the signals are mixed at the moment, so they will probably hold off," said Kelly Tonkin of Lehman Brothers.
CSFB economists said: "Given that no key members of the governing board have shifted significantly from the tone of the last press conference, we continue to expect the ECB to ease after the summer recess, probably on August 30, rather than this week."
Of 37 economists polled last week by AFX News and Agence France-Presse, 31 said they expected the ECB to keep the minimum bid rate on its main refinancing operations at 4.50 pct at Thursday's meeting.
Four predicted a cut in the refi rate to 4.25 pct while one forecast that the rate will be lowered to 4.00 pct. One said the rate will be cut this summer, without specifying a date. But most of those polled -- 25 of the 37 -- said they expect the ECB to cut rates on Aug 30 or in September. Many economists said additional evidence of weakening economic activity could prompt the ECB to ease monetary policy after the summer recess.
The ECB has so far taken a fairly optimistic view of the extent of the economic slowdown in the euro zone, sticking to its forecast that euro zone growth will be within its 2.0-2.5 pct estimate for medium-term trend growth this year.
Private sector economists are less optimistic. Many have cut their forecasts for 2001 growth to 1.6-1.8 pct and say the ECB is too complacent.
"Even though the latest economic releases are all supportive for lower rates, the ECB still seems to be complacent in its current policy stance," said Eckhard Schulte and Rainer Guntermann of Dresdner Kleinwort Wasserstein. "The conviction throughout the entire council clearly seems to be that the economy will bottom out soon and that a recovery will materialise in the second half of the year."
Marc Touati of Natexis Banques Populaires said the ECB should cut rates by 50 basis points this week if it wants to avoid pushing euro zone growth below 2 pct and German growth below 1.5 pct.
"The ECB does not have an economic growth target, but nor is its aim to squash growth in euroland, particularly in Germany," he said. But most economists said the ECB is unlikely to find enough evidence in rece nt data to prompt it to cut rates this week. Even the further decline in the German Ifo index in June is not expected to persuade the council to move, given Duisenberg's insistence that the ECB focuses on euro area wide data rather than national indicators. However, figures released in the next few weeks could lead the ECB to a different conclusion on Aug 30.
"The downward trend in inflation and a further deterioration in leading indicators could push the ECB to change its point of view," said Anne Beaudu of Credit Agricole.
Anja Hochberg of Credit Suisse said she currently expects no further rate cut this year, but data over the next few weeks could prompt her to reconsider this view.
"It depends on the indicators coming over the August period. The possibility of an interest rate cut has slightly risen. We are thinking about changing our minds but we haven't decided it yet. We will wait until the end of August before we consider changing our opinion," she said.
Hochberg said close attention will be paid to leading indicators, particularly the Belgian National Bank's economic health indicator, which leads euroland trends by around one quarter. As well as looking for signs of weakening activity in the economic data, markets will also be watching for any shift in the ECB's tone ahead of the Aug 30 meeting.
"My view is that the ECB will revise gradually down its medium term expectations on growth and inflation," said BSCH's Andres Munoz. The ECB's August monthly bulletin, to be released on Aug 9, will be studied particularly closely, economists said. The monthly bulletin often mainly echoes comments made by Duisenberg at the news conference the week before, but the August bulletin will not be preceded by a news conference and therefore is likely to contain more new analysis. In addition to a possible shift in the ECB's thinking on the growth outlook, economists will also be looking to see if the central bank is now less concerned about inflation.
Euro zone inflation dropped to 3.0 pct in June from its May peak of 3.4 pct, and preliminary German and Italian data suggest that it may ease further in July.
But Duisenberg told the last news conference that the ECB's forecast that inflation will next year finally fall back below 2 pct -- the ceiling for its definition of price stability -- was based on unchanged interest rates, so there is no reason to assume that the decline in inflation towards this level will automatically trigger a cut in rates, economists said.
"My view is that the ECB will revise gradually down its medium term expectations on growth and inflation," said Andres Munoz. And two recent developments could even make the ECB more worried about inflation than it was at that time.
"OPECs decision to cut oil output as well as further reports of firms increasing prices ahead of the euro changeover highlight the dilemma the ECB could face if it cuts interest rates. Even the slightest increase in inflation in coming months -- which is possible even without a renewed price shock due to different base effects at work -- could renew inflation fears and increase long-term yields," said Ulla Kochwasser of Industrial Bank of Japan.
Certainly the ECB does not seem to be in any rush to react to the decline in inflation from its May peak. Bundesbank president Ernst Welteke said recently: "We must wait for a while (to see) if this trend in price decline is really a general one."
Welteke also said that a stronger euro would limit external inflationary pressures and "possibly open the room for manoeuvre for an interest rate cut".
Strong M3 money supply growth would normally also be seen as an indication of inflation pressures, but at the moment the ECB does not seem too concerned about the current high M3 readings.
M3 grew 6.1 pct year-on-year in June, up from a year-on-year growth rate of 5.1 pct in May, but the ECB clearly believes that underlying M3 growth is running well below the 6.1 pct headline June figure. It estimates that the inclusion of non-resident holdings of money market paper and short-term debt securities is now inflating M3 growth by around 0.75 percentage points, instead of its 0.5 point previous estimate.
If the 0.75 point distortion is subtracted from the 5.3 pct figure for average year-on-year M3 growth in the April-June period, then underlying M3 growth is very close to the 4.5 pct reference value, economists noted.