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ECB inches towards end of crisis lending

FRANKFURT (Reuters) - The European Central Bank took a small step toward unwinding its extraordinary support for the euro zone economy Thursday, but it forecast a fragile recovery and left much of its cash buffer for banks in place.

Outside view shows the Euro sculpture in front of the headquarters of the European Central Bank (ECB) in Frankfurt September 18, 2008. REUTERS/Alex Grimm

The ECB said it would return next month to competitive tenders for three-month loans to banks, a sign that it is more comfortable with money market conditions and the latest stage in a gradual withdrawal of billions pumped into banks in the worst days of the financial crisis in 2008.

But it balanced the move by extending unlimited funds at flat rates at weekly and monthly lending operations until October, longer than most analysts had expected, and promised to lend banks extra three-month funds to prevent a spike in rates.

ECB President Jean-Claude Trichet said the moves, which he said were decided by “overwhelming consensus” rather than unanimously, were appropriate given markets’ progressive return toward normality.

They carried no message for interest rates, which the ECB held at a record low 1 percent for the 10th month in a row.

“There should be no interpretation in terms of monetary policy stance of what we are doing in this gradual and timely unwinding of the nonconventional measures,” Trichet told a news conference.

The euro slipped versus the dollar on expectations euro zone rates may remain low for longer than in the United States, while Euribor rate futures fell on expectations of lower liquidity ahead.

Trichet said he expected overnight EONIA rates to remain low in the short-term and the supply of liquidity would be “abundant” at least until July 1, when banks must repay a massive 442 billion euros in 12-month funds.

The ECB also said it would index the rate at the final offer of six-month money in March to the main refi rate, as expected, and offer extra fine-tuning funds around July 1.

UNEVEN RECOVERY

All of the world’s major central banks have been steadily reining in their extra support for the economy, and the withdrawal of the banking liquidity steps is seen as a precursor to eventual rises in interest rates.

The Bank of England also kept rates on hold Thursday, at 0.5 percent, and made no changes to its unprecedented asset-buying program.

The ECB’s new staff forecasts for growth showed little improvement from the last update last December, underlining that Europe’s economic recovery looks far from firmly set.

Growth in 2010 was seen in a range of 0.4 to 1.2 percent from between 0.1 percent and 1.5 percent in December. Growth in 2011 was put at 0.5 to 2.5 percent from 0.2 to 2.2 percent.

“The latest information has also confirmed that the economic recovery in the euro area is on track, although it is likely to remain uneven,” Trichet said.

“Overall, the Governing Council expects the euro area economy to grow at a moderate pace in 2010 in an environment marked by continued uncertainty.”

Analysts say making banks bid again for the longer-term money will make it easier for the ECB to reduce excess liquidity as it gradually normalizes financing and starts to push up overnight interest rates toward the main refinancing rate.

But they say the move will probably be accompanied by high allotments to avoid financial system hiccups.

The rate decision came as no surprise, as the 87 economists polled by Reuters were unanimous this month in seeing no change in rates and on average expected the first rise only in the fourth quarter. Money markets expect no increases until well into next year.

ECB staff saw inflation in a range of 0.9 to 2.1 percent in 2011 from 0.8 to 2.0 percent in December’s forecast, the crucial period for today’s monetary policy decisions given the long lead time and implying little need for rapid interest rate rises.

“This (rate decision) is just confirmation that the economic outlook warrants low interest rates,” said RBS economist Silvio Peruzzo.

The Bank of England also kept its rates on hold Thursday, at 0.5 percent.

Additional reporting by Kirsten Donovan in London; writing by Krista Hughes and Patrick Graham; editing by John Stonestreet, Ron Askew

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