ECB's Draghi seen pushing credibility of low rates promise

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Mario Draghi

Keeping rates on hold will be the easy part of the European Central Bank meeting on Thursday: the harder job will be chief Mario Draghi having to balance talking up euro zone recovery and talking down market rates.

Recent economic data has come in relatively strong, largely validating the ECB's main scenario of a gradual recovery taking hold in the second half of this year and gathering pace in 2014.

(Read more: Enjoy Europe cheer while it lasts, October looms)

However, a rise in forward market interest rates has already caused consternation among the bank's policymakers. Draghi cautioned last month that market expectations of an interest rate rise are "unwarranted".

That verbal intervention did little good, and market rates have continued to rise despite the warning and the ECB's July assurance that it would keep its policy rates at current or lower levels for an extended period of time.

Much of the market rate pressure is linked to the global impact of the U.S. Federal Reserve heading towards cutting back its stimulus program - a dominant factor in global finance.

But a cacophony of policymaker views on what the ECB's first stab at forward guidance actually means has diluted its impact and analysts say the central bank's main challenge this month is to make it more credible instead of lowering interest rates.

(Read more: ECB's Draghi confirms forward guidance)

"A rate cut does not seem to be likely. Of course that remains an option in the future," ABN Amro economist Nick Kounis said. "Probably they'd get more mileage from strengthening the guidance first."

All 60 economists in a Reuters poll expect the ECB to keep interest rates at 0.5 percent at Thursday's meeting.

But it is far from clear that the 23-man Governing Council can agree on a firmer formulation of guidance, either by giving a time frame during which they will refrain from raising rates, or a clear data point to be reached before a rate increase.

Even as the ECB is expected to keep rates on hold, Draghi is likely to stress that a cut remains an option in the future, confirming the downward bias on monetary policy.

(Read more: Watch out: euro zone recovery faces 'serious headwinds')

In August, Draghi gave no indication the policymakers were entertaining a chance of cutting rates further, which did not help in keeping market rates from rising.

"Last time, one of the mistakes Draghi made was saying they didn't even talk about a rate cut," Kounis said.

While waiting before any action, Draghi could stress the ECB still has other tools, including another ultra-long-term liquidity measure to tide banks over a potentially rocky period of asset-quality review and stress tests over the next year.

Southern comfort

Euro zone businesses had their best month in over two years in August as orders increased for the first time since mid-2011, a survey showed on Wednesday, suggesting the region's economy will grow slightly this quarter after 0.3 percent growth in the second.

The Governing Council will also welcome the fact that interest rates banks charge companies in debt-ridden southern Europe are falling more than in core euro zone nations, even as the gap between them remains wide.

Widely varying borrowing costs across the 17-country bloc have developed into a major headache for the central bank, which charges banks a flat 0.5 percent interest rate for loans.

(Read more: Euro zone recession rending, but what has changed?)

In July, the interest small businesses have to pay fell most in the debt-ridden countries and the central bank's measure of country-by-country variation fell to its lowest level since August last year.

However, the amount of money euro zone firms borrowed fell at its fastest pace since the inception of the euro in July.

Weak lending, combined with rising market rates, will keep the ECB from putting a much happier face on the growth outlook in its latest set of staff economic projections to be published on Thursday, and Draghi is expected to emphasize that the growth outlook is still subject to downward risks.

(Read more: Seeking European signs of sturdier global rebound)

"Draghi will be very cautious on the growth outlook, repeat what they have said before, that they are on track with a very gradual recovery," Societe Generale economist Anatoli Annenkov said.

Analysts also expect the inflation outlook to remain close to current levels, showing no price pressures as it is expected to remain below the ECB's target of just below 2 percent.

"We are not expecting much change in the inflation outlook, next year's inflation estimate should be 1.3 or 1.4 percent," SocGen's Annenkov said.