Euro Rates Stay on Hold; Trichet Softens Stance

The European Central Bank left interest rates unchanged as expected on Thursday despite the financial turmoil engulfing European banks and increased signs of weakness from the euro zone economy.

European Central Bank President Jean-Claude Trichet said the bank was determined to fight inflation but admitted there was a risk of economic slowdown.

"The most recent data clearly confirmed that economic activity in the euro area is weakening," Trichet told a news conference. "Upside risks to price stability have diminished somewhat but have not disappeared."

There is a growing belief that rate cuts are now inevitable, the only question is when. Since the ECB last met, gloomy economic data and a rise in unemployment have suggested a euro-zone recession is increasingly likely while inflation fears have been eased by further drops in oil and commodity prices.

"What we will see will be… lower rates, no later than the end of the year,"  Ansgar Belke from the University of Duisburg told CNBC.

The euro fell against the dollar as investors took Trichet's remarks as a sign that he and his ECB colleagues see the global turmoil of the last few weeks inflicting enough damage on the euro zone's economy to warrant possible interest rate cuts.

Trichet refused to speculate on the ECB's next action, saying that "the availability of bank credit has as yet not been considerably affected by the ongoing tensions."

"We discussed extensively the recent intensification of the financial market turmoil and its possible impact on economic activity and inflation, recognizing the extraordinary high level of uncertainty stemming from the latest developments," he also said.

He said the European Union was not fit for a pan-European fund to rescue troubled banks, noting that, unlike the U.S., the 27-member bloc does not have a federal budget.

"There are cases where we need decisions by governments," Trichet said.

Several European government sources have said France, which holds the rotating European Union presidency, had floated the idea of a 300 billion euro ($418 billion) EU bank rescue fund, although Paris denied the existence of such a proposal.

(What Do You Think Will Help European Banks the Most? Vote in Our Live Poll)

French President Nicolas Sarkozy, who will host a meeting of with the leaders of Germany, Britain and Italy, Trichet and others on Saturday, publicly said no EU-wide bailout was in the works and denied a 300 billion euro fund was under consideration.

Trichet said the liquidity squeeze had intensified after the bankruptcy of investment bank Lehman Brothers last month.

"What we are observing, in all markets…is that we have a difficulty to have a market functioning normally," he said.

Banks had the tendency to underestimate the risks they were taking and now "we have the reverse phenomena, the pendulum went too far," Trichet said. "All authorities, governments have to be up to their responsibilities."

Emerging economies such as Asia, Latin America and Central and Eastern Europe showed remarkable resilience but they should remain vigilant, he said.

"It was the first time that we saw more resilience in developing world than in industrial world. That being said, it is no time for complacency for the emerging world," Trichet said.

(Watch Peter Hemmington from BDO Stoy Hayward and Klaus Baader from Merrill Lynch discuss the rate decision above).

-- Reuters contributed to this report

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