5 Min Read
* ECB holds low cost of borrowing steady at August meeting
* Draghi expected to flag risks from Ukraine
* ECB hopes new schemes will prompt banks to lend (Adds detail of decision, background, analyst comment)
By Eva Taylor and John O'Donnell
FRANKFURT, Aug 7 (Reuters) - The European Central Bank held borrowing rates on Thursday as it pinned its hopes on lending measures to bolster a struggling euro zone economy facing further damage from the Ukraine conflict.
Having cut interest rates to record lows in June, the euro zone's central bank kept them steady, waiting to see whether schemes such as the ultra-cheap four-year loans to banks it will launch in September will prompt them to lend more.
The decision by the ECB's Governing Council, with representatives from the 18 countries that use the euro, had been expected by economists.
Many are now shifting their attention to next year, when they hope the ECB will follow the United States and other major central banks in launching a money-printing programme known as quantitative easing to buy assets such as government bonds.
"The euro zone is at a crossroads and the economy can go either way," said James Knightley, an economist with ING.
"We are starting to see some signs of stagnation and the geopolitical situation is adding to the risks. Can the weaker euro and better credit conditions offset that? If they don't, that will force the ECB's hand."
Heightened tensions between Russia and Western countries over the conflict in Ukraine have already hit business confidence in the euro zone.
Russia has banned imports of fruit and vegetables from the European Union in retaliation for sanctions against Moscow, while NATO warned this week that Moscow could use the pretext of a humanitarian mission to invade eastern Ukraine.
Nonetheless, many economists do not expect a reaction from Frankfurt unless there is a dramatic turn for the worse.
"The geopolitical situation is increasing risks to the economy but we don't expect them to change course until next year," Societe Generale economist Anatoli Annenkov said.
"We expect the ECB to launch an asset purchase programme early next year, buying private-sector rather than government bonds at the outset. But for the time being, they are going a different route to encourage lending."
In June, the ECB became the first major central bank to charge banks for holding their deposits overnight, a step designed to stop them hoarding cash and lend instead. It will also roll out the new programme of cheap loans tied to lending to smaller euro zone businesses from next month.
ECB President Mario Draghi is expected to address the risks posed by Ukraine when he speaks at a news conference after the rate announcement.
But he is unlikely to drop any hints as to when the central bank could start a money-printing programme, a contested step that would be deeply unpopular in Germany, the biggest economy in the bloc.
With price inflation, a key yardstick of the strength of the economy, at record lows, some investors are growing impatient.
"The question will be 'how much closer does this get us to QE?" said Richard Barwell, an economist with RBS. "He has to walk a tightrope between sounding too complacent and sounding too gung-ho."
As well as Ukraine, the euro zone faces other hurdles.
Data this week showed Italy, the third-biggest euro zone economy, has slipped back into recession while the Bundesbank says even powerhouse Germany stagnated in the second quarter.
Italian Prime Minister Matteo Renzi has led calls to move away from spending austerity to adopting looser EU budget rules, but has been rebuffed by Berlin.
Draghi, an Italian, may also join this debate, which has divided southern euro countries such as Greece from northern partners such as Germany, to pressure Renzi not to abandon economic reform.
In France, the region's second biggest economy which is also struggling, President Francois Hollande said the ECB and Germany must do more to boost growth and fight a "real deflationary risk" in Europe.
Euro zone inflation hit a paltry 0.4 percent in July, the lowest in more than four years.
Low prices are partly a result of spending cuts and lower wages, reforms the ECB does not want to hinder. But if prices get stuck at low levels, the ECB insists it is ready to act. (Additional reporting by Paul Carrel in Frankfurt; Writing by John O'Donnell; Editing by Catherine Evans)