October 28, 2011 / 2:13 PM / in 6 years

Euro zone rates on hold as guard changes

FRANKFURT (Reuters) - Euro zone interest rates will very likely remain on hold next week as the European Central Bank navigates the transition to new leadership, with an anti-crisis plan forged by EU leaders taking some heat off monetary policymakers.

<p>A man walks past an index board at a hall of the Athens Stock Exchange, October 27, 2011. REUTERS/Yiorgos Karahalis</p>

The bank’s November 3 meeting will be the first chaired by Mario Draghi, who takes over the ECB presidency at the beginning of next month after six years at the helm of the Bank of Italy.

Draghi will want to give the ECB’s communications with financial markets his own stamp -- a process he kick-started on Wednesday by signaling the bank stands ready to press on with the bond-buying program it relaunched in August.

More than that, however, he will want to avoid surprising markets on his debut.

With Italy increasingly mired in the sovereign debt crisis, Draghi’s position is a delicate one, as any fresh gesture of support in that direction could easily be viewed -- especially in the euro zone’s largest economy Germany -- as bias toward his country.

On the other hand, if the ECB pulls away existing crisis support he could face criticism from southern Europeans for taking his cue from Berlin and the Bundesbank.

Draghi is thus likely to start his tenure with a low-key approach and keep rates where they are even as euro zone growth falters and the chances of recession grow.

“I think it is quite difficult for the ECB to entertain the thought of a move (in interest rates) in November,” said Citi economist Guillaume Menuet.

“Draghi’s just arriving, headline inflation is still high, there is no evidence yet of a significant downturn in the hard data.”

In a recent Reuters poll of 70 economists, around two thirds predicted a rate cut by December and 11 said it would happen on Nov 3. Seven said the bank would wait until next year and 16 that the bank will not cut rates.

Some ECB governing council members wanted to cut rates last month, while others think they can stay at 1.5 percent for now.

“The current interest rates are adequate,” said ECB Executive Board member Juergen Stark, a monetary policy hawk who is resigning from his post this year -- a move ECB insiders say is in protest at the bond-buying program.

GROWTH CONCERNS

Many ECB policymakers -- among them Draghi -- are worried about intensifying downside risks to growth and if economic data keeps its current trend, the central bank is likely to change its course and cut interest rates in December.

“The risks of a further weakening in growth prospects are significant, in a context of great uncertainty,” Draghi said on Wednesday ahead of the EU summit, singling out the sovereign debt crisis as hurting confidence.

But the positive market reaction to Thursday’s debt plan gives the ECB more time to assess the risk of recession and whether to cut rates.

Moreover, with inflation persistently above the ECB’s target of just below 2 percent -- it was 3.0 percent in September -- real short-term interest rates are negative. Annual German inflation eased in October but only marginally to 2.5 percent from 2.6 percent the previous month.

“I don’t think there is a particularly strong case for a rate cut in the euro area, unless the euro area is going into a recession,” Societe Generale economist Klaus Baader said.

“There are a lot of problems... but an excessively high short-term interest rate is not one of them.”

During the darkest hours of the financial crisis, the ECB lowered its rates to 1.0 percent, keeping them higher than the 0.5 percent in Britain and the close-to-zero approach taken in the United States and Japan. Before that, the lowest ECB rates had reached were 2.0 percent, still above the current levels.

Some economic indicators have held up relatively well. Euro zone economic sentiment eased only marginally in October, raising hopes the bloc’s economy may escape a contraction in the fourth quarter, and money supply figures were stronger than expected.

But not all is well -- business surveys showed the bloc’s economy is in serious danger of lurching from stagnation into outright recession.

SMOOTH-TALKING ITALIAN

With the new-look ECB still on training wheels next month, many ECB watchers are eyeing December as the time to trim rates -- by when data should provide more evidence whether a recession is in the cards or not.

The 17-country bloc’s central bank also often likes to move rates when it publishes new staff projections for growth and inflation, and Governing Council member Ewald Nowotny dropped a strong hint this will be the case again in December.

“We will of course discuss interest rate policy again when we have new forecasts,” he said last week.

Outgoing president Jean-Claude Trichet’s had a strong track record in preparing the ground for interest rate moves, and analysts will expect this tradition to continue.

“Communication is probably a consideration (in rate cuts), making sure that it goes smoothly,” ABN Amro economist Nick Kounis said.

“There might be some concern that his first action should not be to surprise people and investors.”

Additional reporting by Paul Carrel; Editing by John Stonestreet

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