Published: Thursday, 5 Nov 2009 | 9:31 AM ET

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The European Central Bank kept interest rates on hold at 1.0 percent on Thursday and investors are now braced for signs that it will soon start weaning banks off cheap and abundant liquidity.

All 78 economists polled by Reuters last week had expected the ECB to leave interest rates at a record low this month, with no change expected until late 2010.

The euro zone economy will recover at a gradual pace next year while latest evidence suggests a pick-up in activity in the second half of this year, European Central Bank President Jean-Claude Trichet said in a news conference after the decision.

"The latest information continues to signal an improvement in economic activity in the second half of this year," Trichet said.

"The Governing Council expects the euro economy in 2010 to recover at a gradual pace, recognising that the outlook remains subject to high uncertainty," he said.

Third quarter euro zone GDP figures are due next week and are forecast to show the currency bloc exited recession, growing by around 0.5 percent from the second quarter.

Trichet hinted at ways to mop up liquidity from the markets.

"Looking ahead and taking into account the improved conditions in financial markets, not all our liquidity measures will be needed to the same extent as in the past," Trichet said. 

"Accordingly the Governing Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion and that the liquidity provided is absorbed in order to counter effectively any threat to price stability over the medium to longer-term," he said.

Exit Strategies?

Investors were braced for signs that the ECB will soon start weaning banks off cheap and abundant liquidity but Trichet said a decision on the ECB's program of offering 12-month money to banks at just one percent would be taken next month.

He added, however, that he would not "dispel" a market view that the scheme would not be extended beyond December.

"I will not comment on the spread or indexed rates. We will examine the situation and take our decision next time," Trichet said.

The U.S. Federal Reserve made no change to policy settings on Wednesday despite growing confidence of a recovery.

The Bank of England also left its rates untouched, but said it would expand its quantitative easing program by 25 billion pounds.

The vast majority of analysts expect the ECB to start withdrawing generous liquidity supplies before it raises rates, and futures pricing suggests market rates rising in early 2010.

Many of the emergency measures brought in to counter the financial crisis run only "beyond the end of 2009," meaning the ECB will have to decide soon whether to extend them or not.

Germany's Axel Weber fanned speculation that the central bank may reveal at least part of its hand on Thursday when he said last week that the policy of unlimited funds at main liquidity operations should be kept on, while very long-term liquidity operations could go sooner.

Weber is so far the only policymaker to announce his preference for how the ECB should exit its support measures, and even he said it was premature to set a concrete time-frame.

Inflation remained negative in October, at -0.1 percent, but is expected to turn positive again in November given a 15 percent rise in oil prices in the last month.

Growth data over the last month have been encouraging, with euro-zone manufacturing activity growing in October for the first time in 17 months and its service sector expanding at its fastest in nearly two years.

All this has boosted expectations that the 16-nation bloc returned to growth in the third quarter.

The European Commission on Tuesday revised up its growth forecast for next year to 0.7 percent and sees an acceleration to 1.5 percent in 2011, after a 4.0 percent fall this year. The IMF sees 0.3 percent growth in 2010.

One threat to that is the strength of the euro, which has risen 16 percent against the dollar in the last eight months and about 3.5 percent using the ECB's preferred trade-weighted measure.

• Slideshow: Central Banker Report Cards

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