ECB Set to Cut Economic Forecasts, but Not Rates

Part of the giant euro sign outside the Eurotower, home of the European Central Bank, in Willy-Brand-Platz, Innenstadt district.
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The European Central Bank islikely to keep interest rates on hold on Thursday but may offerclues on its policy path for next year with updated forecastslikely to present a grim outlook for the euro zone economy in2013.

Since announcing a new bond-buying plan in September, theECB has held off on further action until the program isactivated. That wait looks set to continue as Spain resists pressure torequest a bailout - a precondition for the ECB to buy its bonds.

Instead, markets may focus on the bank's new economicforecasts for hints on the course of monetary policy. The bankis sure to cut its growth outlook for this year and next as theeuro zone crisis has hurt the economy right to its the core,including Germany.

With market interest rates varying greatly across the17-country bloc, the ECB is focused on fixing what it calls the'transmission mechanism' for passing on its rates beforecontemplating lowering official borrowing costs, already at arecord-low level of 0.75 percent.

"We do not expect any change in rates," Danske Bank analystAnders Moller Lumholtz said. "We expect a very calm meeting. Draghi has been pointingrecently to improvements in market sentiment, and it's ourexpectation that he will do it also in Thursday's meeting."

Only a handful of the 71 economists polled by Reuters saidthe ECB would trim its main rate to 0.5 percent from 0.75percent. They were split down the middle over the possibility of acut early next year, however, putting the focus back on theECB's new economic projections.

"With disappointing macro data and the ECB poised to lowerits growth forecasts, the prospect of a further reduction in therefi rate at least is back in the cards for next year," Investececonomist Philip Shaw said.

Business surveys showed on Wednesday the euro zone'seconomic slump was a little less pronounced in November thanpreviously thought, although there are few signs the region willemerge from recession any time soon.

The unemployment rate rose to record high 11.7 percent inOctober, with the southern European countries suffering most. The quarterly update of staff projections will reflect thewoes, with economists expecting a downgrade to growth forecastswhile the inflation outlook will remain largely the same.

In September, the projections pointed to gross domesticproduct (GDP) growing about 0.5 percent in 2013 after a slightcontraction this year.

The split in rate expectations shows that ECB watchers havea tougher time deciphering ECB President Mario Draghi's languagethan that of his predecessor, Jean-Claude Trichet, who usedcoded language to flag rate moves often months in advance.

"Certainly in terms of communication, Draghi has thrown awaythe codebook," Shaw said.

Reaching Limits

Governing Council member Erkki Liikanen said last week theECB has already done a lot to soften the blow from the euro zonedebt crisis. The central bank is pressing the bloc's governments to actnow and is wary of taking any action that could see themsoft-pedal budget-consolidation efforts.

This puts the onus on Spain to prompt fresh ECB action -Madrid must turn to its European partners and ask for a fullbailout, on top of the aid granted to its banking sector, beforethe ECB can intervene and buy Spanish sovereign debt.

The ECB has not yet bought any sovereign debt under its newbond-buy programme - dubbed Outright Monetary Transactions (OMT)- but by saying it could buy unlimited amounts of governmentbonds it has calmed markets.

Spain auctioned fewer bonds than it hoped to on Wednesday,prompting markets to ditch the country's debt as investors fretover the timing of an expected aid request by the government.

However, yields fell from previous sales, reflecting arecent rally in prices since Draghi unveiled the bond plan. With Spain's borrowing costs at a manageable level, the waitwill continue as long as markets trust the ECB to interveneforcefully when the time comes, with its credibility reducingits need to act.

"At this stage, it doesn't seem that Spain is very focusedon asking for this assistance. There has been tightening inperipheral yields based on the Chuck Norris effect," DanskeBank's Lumholtz said, referring to the impact of the threat ofECB action. "The central bank has been very clear that they arewilling to engage in bond purchases."

As banks are still wary of lending to each other, the ECB isuniversally expected to extend its policy of offering banksunlimited amounts of cash in all its refinancing operations. It started the policy in 2008, after the Lehman Brotherscollapse, and has continued it ever since, with no end to it insight.