European Central Bank policymakers are expected to leave interest rates unchanged on Thursday despite an unexpectedly sharp drop in inflation and slow growth in the single currency bloc. Financial markets will scour the policy statement read by ECB President Jean-Claude Trichet for any hint of easier credit ahead now that the central bank appears to have reached its goal of price stability much faster than expected. "If Trichet doesn't mention that rates are appropriate, it immediately will be an invitation to speculate on a rate cut at the next meeting. That's the thing to watch," said Joachim Fels, an economist at Morgan Stanley in London. Analysts said the Trichet was most likely to deliver an unchanged message that interest rates at their current historic low of 2.00 percent are sufficient both to keep prices stable and allow the economy to gradually return to cruising speed. Annual euro zone inflation slid to 1.6 percent in February from 1.9 percent in January. With a further slowdown expected in March, the ECB is almost certain to reach stable prices in 2004, analysts said.
The precipitous drop in the euro , which on Wednesday traded as low as $1.2059 after reaching a record high of $1.2927 in mid-February, undermined calls for rate cuts, they added. "The euro is giving the ECB a massive amount of relief," said Christel Aranda-Hassel, an economist at CSFB in London. Short-term interest rate futures , that were last week pricing in a strong chance of a rate cut by June, now attached a mere five percent probability of such a move as the euro fell below $1.22. The view that the ECB could signal readiness to cut borrowing costs was based in part on the unexpectedly rapid slowdown in inflation to below the ECB's two percent ceiling.
EURO CONCERN
While the euro's decline has taken some of the heat off the ECB for the moment, the speed of recent swings in its external value means it could become a burning issue again quickly, which may temper any remarks Trichet might make about the currency. "He won't elaborate on the recent move because he knows that exchange rates are very fickle. He will reiterate that they do not like exchange volatility," predicted Morgan Stanley's Fels. The ECB interest rate announcement is due at 1245 GMT with Trichet's news conference to explain the decision at 1330 GMT. The ECB has been under huge pressure from euro zone politicians to cut borrowing costs to offset euro strength. German Chancellor Gerhard Schroeder and French Prime Minister Jean-Pierre Raffarin publicly appealed for rate cuts last week. Those calls were quickly echoed by industry groups concerned that the surging euro would stifle their ability to compete. The euro's gains were blamed for setbacks in some key euro zone business confidence indicators in February, such as Germany's Ifo business climate index, and raised concerns that the currency bloc's snail-paced recovery might stall. "In the euro area, we are still relying only on exports. To kill that before the recovery has spilled over into the domestic economy is very dangerous," CSFB's Aranda-Hassel said. Euro zone gross domestic product grew by 0.3 percent in the fourth quarter of last year, below the consensus expectation and providing a weaker launch into 2004 than many had hoped. ECB staff economists have also reportedly trimmed the growth and inflation outlook marginally this year by one-tenth of a percentage point -- to 1.5 percent and 1.7 percent respectively, and inflation for 2005 by the same amount to 1.5 percent. But analysts said the possible slight changes in the ECB's projections and dampened confidence at the start of the year in some countries would not prompt the ECB to hasty action. Only one of 62 economists surveyed by last week thought the ECB would cut interest rates this week. Most see the ECB keeping rates on hold throughout the year. "The downside surprises have not been big enough to warrant a major change in the ECB's assessment," Morgan Stanley's Fels said.///