ECB seen holding rates steady as it waits to unlock bond plan

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By Eva Kuehnen | November 8, 2012 11:21 AM EST

The European Central Bank is expected to leave interest rates on hold on Thursday, waiting instead to show its mettle with a new bond-purchase programme that is ready for use as soon as Spain asks for help.

The bank said last month it was ready to buy bonds of debt-strained governments such as Spain and Italy once they had signed up to a European bailout programme. So far no request has been made, but the announcement alone has calmed markets.

Underlying economic problems persist, however, and gloomy data indicated earlier this week that the euro zone economy risked shrinking more than expected in the fourth quarter, which the ECB could eventually respond to by cutting rates.

While a Reuters poll gave an 80 percent chance the ECB will hold its main refinancing rate at 0.75 percent on Thursday, most of the 73 analysts polled expected it will be cut to a new record low of 0.5 percent within the next few months.

"We expect the ECB to remain firmly on hold," said Goldman Sachs economist Dirk Schumacher. "Neither the data that have become available since last month nor actions from euro area governments justify additional measures at this point."

Before cutting rates further, the ECB will focus on making sure that its record low rates reach companies and households across the euro zone, a mechanism that has been broken by the debt crisis.

The new bond-purchase plan -- dubbed Outright Monetary Transactions (OMT) -- is the ECB's designated tool to fix this mechanism. It just needs to be activated and that can only be done by the respective governments requesting a bailout.

CALLING FOR HELP

Investors and euro zone policymakers have been urging Spain to seek aid from Europe's bailout funds, but Spanish Prime Minister Mariano Rajoy has so far avoided seeking help, saying he wants assurances ECB intervention would bring down Spain's debt costs.

Pressure has eased somewhat as yields on Spanish government bonds have dropped by around 2 percentage points since ECB President Mario Draghi said in late July the ECB was ready to do "whatever it takes to preserve the euro" - a pledge that heralded the bond-buying plan.

Some economists have now raised the possibility that the OMT might not have to be activated considering its impact so far.

But Matteo Cominetta, European economist at UBS, said eventually the OMT would be put the test because of the large amount of Spanish sovereign debt coming up for renewal next year - roughly 140 billion euros according to Reuters data.

"Next year, you will have a record supply of Spanish bonds up for renewal in a situation where macro economic data will remain very bad for a long time in Spain," Cominetta said.

The European Commission said in its autumn forecasts on Wednesday that Spain would suffer a recession almost three times deeper at 1.4 percent in 2013 than the 0.5 percent contraction predicted by Madrid, unless it takes additional steps.

The Commission also said the euro zone economy would barely grow next year, but pick up in 2014.

Draghi said in a speech on Wednesday that economic activity was expected to remain weak in the near term and that this combined with slow money growth meant the risks of inflation were very low over the medium term.

Euro zone inflation eased in October to 2.5 percent year-on-year from 2.6 percent in September, thanks to slower energy price growth, though it stayed above the ECB target of below but close to 2 percent.

(Reporting by Eva Kuehnen. Editing by Jeremy Gaunt.)

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