FRANKFURT, Feb 5 - The European Central Bank is expected to hold interest rates steady on Thursday as the euro's recent retreat means the ECB can stick to its outlook for a budding euro zone recovery and benign inflation. The central bank may keep rates steady well into this year to allow the 12-nation currency bloc to reach its cruising speed, even though some analysts had said the euro's earlier rise would force it to cut rates once more. But with the single currency off record highs and with few expecting it to cross pain thresholds soon, the ECB's meeting is bound to contain few surprises. "Clearly, there will be no change in rates. But more than that ... (they) will try to use as much as possible the wording and comments used in the past, giving the impression there is no change at all in the stance," said Bank of America economist Lorenzo Codogno in London. Europe is unlikely to find U.S. support for any strong statements to talk the dollar up at a weekend meeting in Florida of the Group of Seven richest nations of the world, whose outcome will be closely scrutinised by currency markets. But still, a first round of verbal intervention by European policymakers including from the ECB, has managed to stop the euro's persistent rise -- 20 percent against the dollar in 2003 -- at a record high just under $1.29 last month, and the currency is now trading around $1.25.
The ECB announces its interest rate decision at 1245 GMT and a news conference with ECB President Jean-Claude Trichet follows at 1330 GMT. All but two out of 69 economists in a poll last week expected the central bank to hold the benchmark rate steady at two percent.
INTEREST RATE GAP NARROWING
One key reason why the euro has eased is a recent signal that the U.S. Federal Reserve might hike rates sooner than expected, as it dropped "for a considerable time" as the period for which it expected to keep rates low, analysts said. "The shift in the Fed's language has helped the dollar to stabilise. Maybe that was one of the reasons for the change in language, and I think Trichet will welcome that," said Jonathan Hoffman, an economist at RBS Financial Markets in London. While many currency strategists see the euro hitting the key $1.30 level in coming months, it is not seen above that on a sustained basis. Mid-range forecasts in a poll this week saw the euro just below that level most of the time. If the single currency does not deviate too much from such levels, the ECB may find little reason to revise its December forecasts for a gradual recovery and tepid inflation, and may hold rates at their current record low, even into next year. It has seen two surprises since the December forecasts, which should roughly balance each other out. One is the stronger euro -- which it had assumed would stay at $1.17. The other is stronger-than-expected global growth. Data so far are confirming that the 12-nation single currency bloc is building up steam on the back of stronger exports, even though consumers remain hesitant.
Business activity in the euro zone's services sector picked up speed again in January, with the Reuters Eurozone Business Activity Index rising to 57.3 from 56.6 in December. Likewise, a similar sentiment indicator for Europe's manufacturing sector inched up to 52.5 from 52.4. Still, companies remained reluctant to hire people in both cases, which may explain some of the consumer spending weakness. "The numbers from forward-looking indicators are consistent with (the ECB's forecasts). I think they would not want to change that," said RBS's Hoffman. The ECB sees 2004 euro zone growth coming in between 1.1 percent and 2.1 percent, implying a mid-point of 1.6 percent.
INFLATION TAME
Short-term interest rate markets are now pricing in that the ECB will gradually hike rates towards the end of the year. Futures contracts see unchanged rates for June, and a 70 percent chance of a half percentage point hike for December. That hike is fully discounted for March next year. Euro zone inflation so far is giving no indication the ECB should be in any rush to upset these bets. A first estimate shows inflation at 2.0 percent in January, unchanged from December and only one notch above the ECB's tolerance zone. The ECB expects inflation to drop below two percent later this year, for a 2004 average of 1.8 percent.//