ECB keeps rates steady, outlook clouded by war

The European Central Bank kept interest rates steady yesterday, confident inflation pressures are easing though wary Iraq war fears could torpedo growth.

The ECB said it left its benchmark interest rate unchanged at 2.75 per cent, the level reached two months ago.

The outcome was widely expected in financial markets, although a surprise quarter-point interest rate cut by the Bank of England yesterday fanned last-minute speculation that the ECB might have moved.

Norman Williams, an economist at Barclays Capital in London, said that despite the ECB's decision to keep rates unchanged, the bank would soon trim borrowing costs given weakening growth, slowing inflation and a resilient euro.

"The ECB will see an increasingly favourable environment for price stability and will, we think, cut rates at the next meeting in March or failing that in April."

The euro dipped slightly against the dollar and the March Euribor future also fell after the ECB's unchanged rate announcement.

The threat of war is pushing up oil prices, unsettling consumer and business confidence and sending money scurrying out of the US dollar into the euro - even as economic data provides a mixed picture on euro zone recovery.

Put together, analysts said this complicates the growth and inflation outlook for Europe.

A wait-and-see posture allows the ECB to avoid a rate cut that might prove overly stimulative were a war to prove short and limited in impact. It also allows the ECB to keep plenty of ammunition dry to fight any sharp downturn triggered by a drawn-out war, analysts said.

Yet the case for a euro zone rate cut is clearly building, and financial markets are bracing for one. Euribor futures contracts, a proxy for rate expectations, now price in a 50 per cent chance of a 25 basis point cut in March and more than a 75 per cent chance of a 50 point cut by June.

A Reuters poll last week also found 39 of 53 analysts forecasting another ECB rate cut this cycle. One factor clearing the path for a future rate cut is that inflation, which is the ECB's primary responsibility to control, is receding. Consumer prices rose in January at a 2.1 per cent annual rate, only just above the ECB's two per cent ceiling and down from 2.3 per cent in December.