ECB holds rates, sees no economy bounce until 2013

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By Eva Kuehnen | November 9, 2012 1:35 AM EST

The euro zone economy shows little sign of recovering before the year-end despite an easing of financial market conditions, European Central Bank Mario Draghi said on Thursday after interest rates were left at a record low.

The ECB held its main rate at 0.75 percent, deferring any cut in borrowing costs while it waits for a cue to use its new bond-purchase programme. That wait may be prolonged after Spain successfully completed its 2012 funding at affordable rates on capital markets on Thursday.

The central bank has said it is ready to buy bonds of debt-strained governments such as Spain and Italy once they sign up to a European bailout programme with strict conditions, under a programme dubbed Outright Monetary Transactions (OMTs).

So far no request has been made, but the announcement alone has calmed markets.

"Economic activity in the euro area is expected to remain weak although it continues to be supported by our monetary policy stance and financial market confidence has visibly improved on the back of our decisions," Draghi told a news conference.

As he spoke, the euro fell against the dollar and hit a session low in early New York trade.

Gloomy data this week indicated the euro zone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates.

Recent survey evidence gave no sign of improvement towards the end of the year and the risks surrounding the euro area remain on the downside, Draghi said.

He signalled the ECB would downgrade its GDP forecasts next month, describing "a picture of weaker economies", and said inflation would remain above the ECB's target for the rest of the year, before falling below two percent during in 2013.

A Reuters poll had given an 80 percent chance the ECB would hold its main rate, but most of the 73 analysts polled expect it will be cut to a new record low of 0.5 percent within the next few months.

Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the euro zone, a mechanism that has been broken by the bloc's debt crisis.

The new bond purchase plan is the ECB's designated tool but it can only be activated once a euro zone government requests help from the bloc's rescue fund and accepts policy conditions and strict international supervision.

"We are ready to undertake OMTs which will help to avoid extreme scenarios, thereby clearly reducing concerns about the materialisation of destructive forces," Draghi said.

Asked whether he could imagine an extreme scenario in which the bank began buying bonds without conditions, he said the answer was 'no'.

CALLING FOR HELP

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

Spain sold 4.8 billion euros of debt including its first longer-term issue in 18 months on Thursday, enough to complete its 2012 financing programme and begin raising funds for next year. So there is little immediate pressure on that front.

Yields on Spanish government bonds have dropped by around 2 percentage points since Draghi said in late July the ECB was ready to do "whatever it takes to preserve the euro" -- a pledge that heralded the bond-buy plan.

Investment funds have started flowing back into the euro zone since then, particularly from U.S. money market funds, Draghi said.

Some economists have now raised the possibility that the OMT might never have to be activated considering its impact so far.

But Matteo Cominetta, European economist at UBS, said it would eventually be put to 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, and said it would miss its deficit targets too.

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

(Reporting by Eva Kuehnen and Paul Carrel, writing by Mike Peacock; Editing by Paul Taylor)

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