* Rates stay at record low of 1.0 pct
* ECB resists German-led pressure to prepare exit strategy
* Spain woes highlight risk of crisis flaring up again
By Eva Kuehnen
FRANKFURT, April 4 (Reuters) – The European Central Bank
held interest rates at a record low of 1 percent on Wednesday
and is expected to resist German pressure to flag an exit from
its crisis-fighting mode as the euro zone recovery looks
increasingly shaky and concerns grow about Spain.
Germany’s powerful Bundesbank has led a push by central
bankers from the euro zone’s core for the ECB to begin preparing
an exit from crisis measures that have seen it loosen the rules
for tapping ECB funding operations.
Attention will now shift to ECB President Mario Draghi’s
1230 GMT news conference for any indications on whether the
central bank is bending to the German-led pressure – an unlikely
scenario as the euro zone economy remains in a fragile state.
Commerzbank economist Michael Schubert said the ECB’s
decision to hold its main interest rate at 1.0 percent was no
surprise. Persistently high inflation and an economy flirting
with recession are effectively cancel each other out.
“After cutting interest rates only a few months ago, the ECB
is now in wait-and-see mode, also to assess the impact of the
three-year loans,” Schubert said. “It will take several months
until this shows up in lending to the real economy.”
The ECB has pumped over 1 trillion euros into the financial
system with twin 3-year funding operations, or LTROs, to head
off a credit crunch that late last year risked exacerbating the
euro zone crisis and jeopardising the currency project.
The German-led group of policymakers is concerned that the
wave of cash risks stoking inflation pressures.
Euro zone inflation eased to 2.6 percent in March – above
the ECB target of just below 2 percent and higher than expected
– but the renewed worries about Spain mean the ECB cannot afford
to signal a rate rise or an exit from the funding measures.
“I think the situation is far too fragile for the ECB to
meddle in exit strategies at the moment, especially if you look
at Spain,” said Berenberg Bank’s Christian Schulz, a former ECB
economist.
” It’s clear the downtrend in yields on sovereign bonds was
triggered by the LTROs. If the ECB were to say ‘well, actually
now we’re thinking about exiting this strategy’, that would
cause concern over whether these low interest rates are
sustainable. That’s why I think they’ll be extremely cautious.”
A rise in government bond buys by banks in Spain and Italy
in February showed they were plying the “Sarkozy trade” – a term
adopted by markets after the French president suggested
governments urge banks flush with ECB cash to buy their bonds.
This trade helped push down yields on Spanish and Italian
government bonds, but the renewed concerns about the public
finances in Spain – the euro zone’s fourth-largest economy –
have sent them higher again.
Returns on Spain’s 10-year bonds fell to 4.65 percent in
early February, after the first of the twin LTRO operations, but
have since risen back to about 5.6 percent.
Draghi will be grilled on how worried he is about the
possibility of Spain having to request a bailout after the rise
in its refinancing costs. Madrid is battling to convince
European partners and debt markets it can rein in its budget
deficit in the face of growing complaints from the public.
WORST OVER?
The ECB believes it has done as much as it can to fight the
crisis and Draghi has put the onus firmly on governments to act.
They responded last week by agreeing to raise their financial
firewall to 700 billion euros ($930 billion).
The ECB is nonetheless concerned that its generous funding
operations have made banks too dependent, and wants to wean
banks off such loans.
The central bank has an ally on that issue in the European
Banking Authority (EBA), which wants banks to stand on their own
two feet and at its board meeting this week is trying to come up
with ways to encourage them to do so.
The bank dependency concerns and Spanish worries are playing
out against a deteriorating economic backdrop across the euro
zone. While Draghi said last month the worst of the crisis was
over, the latest economic data show the economy stumbling again.
Sagging orders kept euro zone businesses in the doldrums in
March, probably pushing the region into a mild recession
although companies became more confident that better times lie
ahead, a survey showed earlier on Wednesday.
The slump means that even though inflation has proved to be
stickier than forecast, the ECB is not about to tighten policy
any time soon. It had to reverse two rate rises last year as the
crisis came back with a vengeance and will be careful not to
repeat the mistake of abandoning its low-rate policy too soon.
Analysts have pushed back their view on the next rate move,
a Reuters poll showed. They now expect rates to have
reached a floor – they equal a record low 1.0 percent – and tip
them to go up late next year at the earliest.
Some economists even believe that, despite pressure from the
hardliners to prepare an exit strategy, the ECB will need to cut
rates again later this year.
“With more negative news on the economy coming through and
probably also inflation to decline further, we still think there
is room for lower rates over the course of the year,” said
Juergen Michels at Citigroup, who expected two more 1/4-point
rate cuts this year to take the headline rate to 0.5 percent.
