European Central Bank holds rates steady

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(Agencies)
Updated: 2008-10-02 21:57

FRANKFURT, Germany -- The European Central Bank left its key interest rate unchanged at 4.25 percent Thursday as the bank appeared to feel inflation fears outweighed concerns about the growing financial crisis that has swept through Europe.

The bank did not immediately outline the reasons behind its decision, but traders will be looking for hints from bank President Jean-Claude Trichet at a news conference later Thursday on whether it could soon lower the rate from a seven-year high amid growing worries about a possible recession.

The 15-nation euro zone is fighting high inflation, low growth and dim short-term prospects for consumer and industrial demand as the global financial crisis unfolds.

Gilles Moec, an analyst at Bank of America, said that Trichet may "state that the economic downturn will be deeper and longer than the Governing Council thought so far."

Trichet may also address the financial market turmoil's effects on the economy. He "could this time explicitly mention the 'rate cut option' when repeating his 'no bias' message, to suggest that the likely next ECB move is down," Moec said.

Howard Archer, chief UK and European economist at Global Insight, said that "further deterioration" in euro zone manufacturing and figures showing inflation easing from 4.1 percent in August to 3.6 percent last month reinforce "our growing belief that the ECB could cut interest rates from 4.25 percent to 4 percent before the end of 2008 as the heightened financial sector turmoil and very tight credit conditions heighten the danger of euro zone recession."

A cut would bring the bank in line with its major peers, but Trichet so far has preferred to stand firm against inflation despite the uncertainty that has exploded in markets in the past three weeks.

Trichet has consistently hammered at the effects of inflation on the euro zone, which includes 320 million people and accounts for more than 15 percent of the world's gross domestic product.

He has gone out of his way to warn about inflation's effects and the bank has kept its interest rate up to combat it.

Higher interest rates can reduce inflation because demand for goods and services can fall as a result of money becoming more expensive. At the same time, higher rates can make it harder for businesses to borrow and expand, with growth slowing as a result.

Instead of cutting rates, the bank has addressed the financial crisis by increasing its short-term lending to banks fearful of lending money to each other, fulfilling its role as lender of last resort.