ECB seen holding rates in prices vs GDP face-off

By George Georgiopoulos Reuters - Thursday, May 8 12:33 pm

ATHENS (Reuters) - The European Central Bank is expected to keep interest rates on hold at 4 percent on Thursday with persistently high inflation facing off against mounting signs of slowing economic growth in the 15-nation region.

Although inflation eased slightly in April from the previous month's record high, it remains, at 3.3 percent, well above the ECB's comfort zone and appears already to be taking a toll on consumer spending and confidence.

In Greece, which hosts Thursday's ECB meeting, economic and consumer confidence has deteriorated in recent months, a picture repeated in bigger euro-zone economies as well.

German manufacturing orders fell unexpectedly in March, as did retail sales, which dropped on the back of record-high inflation which is sapping consumer demand.

Analysts said the latest data highlighted the dilemma facing Europe's central bankers.

"The ECB's job just gets tougher," Fortis economist Nick Kounis said.

"We think that the most likely result will be continued tough talk from the central bank on inflationary risks combined with no change in interest rates. Indeed, we continue to see interest rates steady at 4 percent in 2008."

ECB policymakers have now started their meeting in Athens, one of their twice-yearly get-togethers outside the ECB's Frankfurt headquarters.

All 83 analysts polled by Reuters expect rates to remain on hold at 4 percent when the Governing Council's decision is announced at 1145 GMT, extending the rate freeze into its 11th month.

ECB President Jean-Claude Trichet will hold a news conference at 1:30 p.m. British time to explain policymakers' latest assessment of the economy.

But analysts expect little change to the ECB's message of upside inflation risks and ongoing uncertainty about growth due to persistent tensions on financial markets.

"The ECB ... is happy to leave its rates at 4 percent and its assessment of the situation remains fairly balanced," Lehman Brothers economists Laurent Bilke and Michael Hume wrote in a note to clients.

"That is unlikely to change dramatically this week."

RATE CUT SCRUTINY

For the longer term, analysts are looking for signs that the ECB will bow to slowing growth and follow the U.S. Federal Reserve and the Bank of England in cutting rates. The BoE also announces its rate decision on Thursday and analysts see no change this month, but another easing in June.

The Reuters poll showed analysts forecast two 25 basis point ECB cuts in the second half of 2008, taking the main rate to 3.5 percent by December. However, many have pushed back the timing of the first cut and only a slim majority see this now coming by September.

Over the last month, financial market expectations have been buffeted by conflicting comments from policymakers, some hinting at potentially tighter rates while others have said this is not an option.

Markets are now pricing less than a quarter percentage point cut by the first quarter of 2009, compared with earlier expectations for rates to fall to 3.25 percent by year-end.

But analysts say markets may have over-corrected. Bank of America economist Holger Schmieding said he saw a 60 percent chance of the ECB cutting rates in October as the domestic situation deteriorates.

The latest appreciation of the euro against major trading currencies alone could take 0.8 percentage points from growth in the second half of the year.

But as the U.S. economy recovers, the U.S. dollar should strengthen to about $1.40 -- compared with a record low of $1.60 reached on April 23 -- and buoy euro-zone growth, allowing the ECB to raise rates again in mid-2009, Schmieding said.

The Financial Times newspaper reported on Thursday that EU and U.S. policymakers were keen to see the dollar rise against the single currency.

Trichet said on Monday after meetings with other top central bankers that global growth should remain robust, despite a slowing in industrialised economies.

He said inflation risks were "significant" although he stressed the comments -- made in his capacity of chairman of the global economy meeting hosted by the Bank for International Settlements in Basel, Switzerland -- should not be taken as a signal on ECB rate moves.

(Reporting by Krista Hughes; Editing by Gerrard Raven)

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