ECB set to act against low inflation, hold fire on bolder steps

Wed Mar 5, 2014 6:06pm EST
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By Leika Kihara

FRANKFURT (Reuters) - The European Central Bank is expected to hold off on cutting interest rates on Thursday, opting instead to loosen lending conditions to fight off the danger of debilitating low inflation.

A slight upward surprise in euro zone inflation in February and initial signs of life in some economies in the region have eased pressure on the ECB to take radical steps.

Quantitative easing - actually buying assets to drive money into the system as the U.S. Federal Reserve and others have done - is politically far too difficult.

Imposing negative deposit rates, essentially charging bank depositors, is also controversial within the euro zone bloc and might not be effective.

But with inflation running in the ECB's "danger zone" below 1 percent - 0.8 percent at last count - the bank is poised to open some money spigots by ending operations to drain funds from the financial system.

The ECB currently "sterilizes" money it puts into the system though bond purchases by withdrawing other money to offset the effect. Stopping this would mean more money available for lending.

The step is easier to swallow for the Bundesbank, Germany's conservative central bank, and meets market expectations for some action by the ECB signaling its resolve to maintain its accommodative policy stance for an extended period of time.

"This could be the compromise solution," said Nick Matthews, economist at Nomura.   Continued...

European Central Bank (ECB) President Mario Draghi waits to deliver a speech at a conference for the 20th anniversary of the establishment of the European Monetary Institute, in Brussels February 12, 2014. REUTERS/Francois Lenoir