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ECB to Hold Line on Bond Buys, Keep Rates at 0.75%

Wednesday, 6 Mar 2013 | 10:32 PM ET
Mario Draghi
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Mario Draghi

The European Central Bank will eschew dramatic action on Thursday to help Italy or other euro zone countries caught up in its backwash, despite the threat of political turmoil in Rome reigniting the bloc's debt crisis.

The ECB is expected to hold its interest rates at a record-low 0.75 percent and keep its growth and inflation forecasts largely unchanged at its monthly meeting.

Its president, the Italian Mario Draghi, will reaffirm that there is no question of loosening the central bank's rules on bond-buying to accommodate Italy, analysts said.

Only if governments commit to economic and debt-cutting reforms will ECB help be forthcoming and after last week's inconclusive election, there is no government in Italy to do so and even when one is formed, it will struggle to ignore the anti-austerity vote Italians delivered.

(Read More: Why the Italian Vote Is a German Failure)

"The rules of the OMT are very clear and there is no way the ECB will depart from those rules," Unicredit economist Marco Valli said.

Italian government bond yields fell on Wednesday as investors put their faith in the ECB's ability to prevent the country plunging into full-blown crisis. Whether true or not, that incrementally eases the pressure on the ECB to act.

Draghi can expect to be peppered with questions at an hour-long news conference as to whether the unused bond programme, dubbed Outright Monetary Transactions (OMT), could soon be deployed.

A Reuters poll of economists showed uncertainty stemming from Italy's election makes it more likely the ECB will have to help struggling countries by buying their bonds at some point but with Spain, not Italy, the most likely recipient.

Only four out of 76 economists predicted a rate cut on Thursday, while a growing minority of respondents - 22 out of 76 expect that, eventually, the ECB will cut its main refinancing rate from 0.75 percent to a new record low of 0.5 percent.

Transmission

While some economic data is dismal - economic output in the 17 nations sharing the euro fell 0.6 percent in the fourth quarter of 2012 - other indicators, including January retail trade, have been better than expected.

Moreover, euro zone central bankers have said that their first priority is to transmit already ultra-easy monetary policy to all corners of the currency area.

"What matters to us is how monetary policy signals are transmitted to the real economy. I would focus more on say lending to companies, to households (than bond yields)," Executive Board member Benoit Coeure said at a Reuters event last week.

Analysts see actions targeted to funnelling money to small businesses and consumers as more likely than an immediate rate cut, which might not help the periphery.

"The ECB would prefer to do something to improve the transmission mechanism of monetary policy, which is where the problem is," Unicredit's Valli said. "If you cut interest rates, you'd benefit Germany and a few other countries which don't need it."

(Read More: ECB Profits From Greek Bonds; Promises Funds for Athens)

One move under consideration is tweaking the rules of securities against which the ECB lends money to banks, but some policymakers - including Bundesbank President Jens Weidmann - are sceptical of the central bank taking additional risk.

"The main problem is that collateral changes imply more credit risk for the ECB, which is controversial," JP Morgan economist Greg Fuzesi said in a note to investors.

The central bank will unveil the latest staff economic projections, which are expected to remain close to the previous round, published in December, which predicted 2013 would be a year of contraction.

Euro zone inflation stands exactly at the ECB's target of just below 2 percent after overshooting it for more than 2 years.

Next year's inflation is currently seen at 1.4 percent and were the estimate lowered even further, pressure would grow on the central bank to push it up by additional easing measures.

In addition to Italy, the bloc's third-largest economy, tiny Cyprus could feature prominently in the news conference.

The island is careening towards an EU bailout and Draghi will be asked to explain whether he sees the country as potentially infecting others, especially if bank depositors - as some have suggested - take a hit as part of the rescue package.

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