UPDATE 3-ECB "ready to act" on rates as economy languishes

Thu Apr 4, 2013 9:20am EDT

* ECB keeps interest rates at 0.75 pct

* Draghi signals rate reduction in the pipeline

* Deploys verbal signal favoured by his predecessor

* Says ECB ready to act, policy discussion "extensive"

By Sakari Suoninen

FRANKFURT, April 4 (Reuters) - The European Central Bank expects a gradual economic recovery later this year but will monitor incoming data very closely and is ready to cut interest rates if necessary, its president said on Thursday.

Addressing a news conference after the ECB held rates at a record low 0.75 percent, the highest level among the world's major central banks, Mario Draghi said discussion at the monthly meeting had been extensive and the consensus was to hold fire.

But he added that the ECB stood "ready to act" because there was no certainty that the euro zone economy would pick up.

"In the coming weeks, we will monitor very closely all the incoming information on economic and monetary developments, and assess the impact on the outlook for price stability," he said.

Draghi's predecessor, Jean-Claude Trichet, used a stock of coded phrases to signal future policy actions something his successor has not previously indulged in. One of those phrases was "monitor very closely" although in the Frenchman's era it more often presaged an interest rate rise two months' hence.

German government bond and euro zone interest rate futures extended gains with market participants saying Draghi's comments laid the ground for a rate cut in coming months.

"In a nutshell, a rate cut or additional non-standard measures cannot be ruled out in May," said Annalisa Piazza at Newedge Strategy.

The ECB is mandated to deliver inflation just below 2 percent. In March, it fell to 1.7 percent.

A survey released earlier on Thursday showed the euro zone's economic decline dragged on unabated in March, marked by a huge drop in French business activity that outstripped even the downturns in Spain and Italy.

"Weak economic activity has extended into the early part of the year and a gradual recovery is projected for the second half of the year subject to downside risks," Draghi said.

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 and Britain, which have launched massive asset purchase programmes with new money and cut rates closer to zero.

ECLIPSED BY JAPAN

The Bank of Japan went a step further on Thursday. Its new governor, Haruhiko Kuroda, shocked markets with a radical overhaul of its policymaking, adopting a new balance sheet target and pledging to double its government bond holdings in two years as it seeks to end nearly two decades of deflation.

Japan is intent on pushing inflation higher, lifting the country out of decades of deflation and minimal growth. The scope of the changes drove the yen lower and knocked the 10-year bond yield to its lowest in a decade.

A number of countries, particularly emerging economies, have already complained about policies which drive currencies lower, threatening a destabilising race to the bottom.

The ECB is unlikely to pursue a similar path, although a stronger euro is the last thing a recession-mired economy requires.

"Our exchange rate is not a policy target. Our exchange rate is important for growth and price stability," Draghi said.

German Finance Minister Wolfgang Schaeuble said Tokyo could not count on central bank actions alone to boost its economy and must carry through with structural reforms.

Earlier this week, ECB Executive Board member Benoit Coeure warned against countries directly pursuing competitive devaluations, especially if other central banks had limited room for manoeuvre.

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 and surveys showed manufacturing across the bloc fell deeper into decline.

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 stressed that the Cyprus bailout -- involving losses imposed on richer bank depositors -- was not a template for future rescues as others have suggested.

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