ECB seen on hold, markets look for signs of later cut

Wed Apr 3, 2013 7:01pm EDT

* ECB expected to keep interest rates at 0.75 pct

* May loosen collateral framework to revive lending

* Rate decision due at 1145 GMT, press conference 1230 GMT

By Eva Kuehnen

FRANKFURT, April 4 (Reuters) - The European Central Bank is expected to hold interest rates on Thursday but investors will be looking for any signs it is preparing for a cut in coming months to help lift the euro zone out of recession.

Despite a recent drop in economic sentiment and falling inflation, a Reuters poll of 73 economists showed little change in expectations, with rates set to remain at 0.75 percent - tiny, but still the highest level among the world's major central banks.

As the world recovers from the financial crisis, the ECB has lent less support to the economy than its peers in Japan, the United States or Britain, who have launched massive asset purchase programmes and cut rates closer to zero.

In Japan, Haruhiko Kuroda is chairing his first meeting at the Bank of Japan at which he is expected to ramp up bond buying and introduce a radical shift in the policy making framework. The Bank of England is expected to wait with further bond buys.

ECB Executive Board member Benoit Coeure warned on Tuesday against countries directly pursuing overt competitive devaluations, especially if other central banks had limited room to manoeuvre.

The ECB itself is unlikely to go down a similar path to its international peers at its policy meeting, not even to boost lending to households and companies in the euro zone periphery, which so far enjoy limited benefit from record-low ECB rates.

"Apart perhaps from loosening some of the collateral rules again, we don't expect that the ECB is yet ready to launch into any programmes in terms of purchases of assets," said Citi economist Guillaume Menuet.

"The Governing Council will be mulling over a change of tone to prepare investors for an easing of monetary policy later in the quarter," said Menuet, who had pencilled in a 25-basis point cut in the main refinancing rate for May or June.

RECOVERY STALLS

After early signs of stabilisation in the euro zone economy at the start of the year, March marked a set back as Cyprus narrowly escaped a financial meltdown by securing a last-minute bailout and Italy struggled to end a post-election deadlock.

Euro zone economic sentiment fell after four months of gains, surveys showed manufacturing across the bloc fell deeper into decline and inflation eased to 1.7 percent, departing further from the ECB's target of below, but close to 2 percent.

One month's readings will not be enough to change the ECB's policy stance, but any indication of heightened concern about growth prospects or the inflation outlook will not go unnoticed ECB President Mario Draghi's post-meeting news conference.

ECB Governing Council member Ewald Nowotny two weeks ago doused hopes for further cuts, saying in the current situation lower interest rates would not have much of an effect. His colleague, Yves Mersch, made similar comments last week.

The ECB's main worry is that its low rates are not reaching households and firms in the euro zone periphery, mainly because banks' funding costs in crisis stricken countries are higher than those in the core countries, pushing up loan costs.

This affects small and medium-sized enterprises (SMEs) in particular as they have few alternatives to bank funding.

Draghi said after the March policy meeting that the ECB was studying options to address the issue, but that they were not planning "anything special". Since then, several policymakers have said a number of options were being looked at.

Nowotny said one plan was to package SME loans, but rejected suggestions the central bank could buy them directly, saying instead that the ECB would work through the banking system.